iiihi 


Mercantile  Credits 

A  Series  of  Practical  Lectures  Delivered 

Before   the    Young   Men  s   Christian 

Association  of  Los  Angeles^ 

California 


BY 

M.   Martin  Kallman;  Alfred  K.  Care;  J.   M.  Elliott; 
Herman  Flatau ;  E.  R.  Purdy;  C.  A.  Parmalee ; 
W.  C.   Mushet;   N.   P.   Conrey ;   Lee  C. 
Gates;  W.  J.  Ford;  F.  C.  DeLano; 
W.  T.  Craig;  Warren  C.  Ken- 
nedy; Frank  G.  Finlayson 


NEW  YORK 

THE  RONALD  PRESS  COMPANY 

1914 


Copyright,  1914, 

by 
THE  RONALD   PRESS   COMPANY 


PREFACE 

The  mental  equipment  of  the  successful  business  man 
of  today  can  hardly  be  too  complete.  The  amount  of  in- 
formation requisite  for  the  proper  conduct  of  his  business 
exceeds  that  required  by  the  business  man  of  any  other 
age.  His  information  must  be  accurate  and  must  cover  a 
wide  scope.  What  he  knows  he  must  know  well.  He  is 
constantly  called  upon  to  pass  upon  questions  of  great 
importance,  and  he  must  decide  without  delay.  His  de- 
cisions must  be  based: 

First,  upon  the  business  wisdom  of  accepting  or 
refusing  the  opportunities  offered. 

Second,  upon  a  hurried  review  of  the  legal  problems 
involved.  It  is  impossible  to  keep  an  attorney 
constantly  at  his  elbow  to  pass  upon  every  trans- 
action, and  therefore  he  must  have  a  working 
knowledge  of  business  law. 

Third,  upon  keen  judgment  of  human  nature  and 
human  character.  The  aphorism  of  Alexander 
Pope,  "The  proper  study  of  mankind  is  man," 
applies  with  greater  force  to  the  business  man 
than  to  others. 

The  National  Association  of  Credit  Men  labors  un- 
ceasingly to  educate  its  members  in  all  those  subjects 
which  are  so  vital  to  their  success.  By  bulletins,  letters, 
lectures,  and  debates,  the  propaganda  has  gone  forward. 

But  the  older  members  of  the  Association  have  found  it 

iii 


304795 


iv  PREFACE 

extremely  difficult  to  secure  junior  clerks  who  have  even 
an  elementary  knowledge  of  the  basic  principles  of  busi- 
ness and  credits. 

In  an  endeavor  to  inform  and  assist  the  members  of 
the  Los  Angeles  Association,  and  to  place  in  training  young 
men  who  might  thereafter  be  available  for  positions  of 
trust  in  credit  departments,  the  Los  Angeles  Credit  Men's 
Association  requested  the  Young  Men's  Christian  Asso- 
ciation of  Los  Angeles  to  establish  a  lecture  course  on 
these  subjects,  and  agreed  to  extend  all  possible  co-oper- 
ation. The  very  excellent  organization  of  the  Young 
Men's  Christian  Association  took  hold  of  the  work  with 
great  enthusiasm,  and  the  result  was  a  series  of  lectures 
which,  it  is  believed,  will  be  helpful  to  all  young  men  en- 
gaged in  active  business,  as  well  as  to  those  contemplating 
such  a  career. 

The  subjects  were  chosen  to  cover  as  nearly  as  pos- 
sible the  fundamentals  of  business  practice  and  business 
methods ;  and  it  is  hoped  that  those  who  faithfully  fol- 
lowed this  course  of  lectures,  and  those  who  now  study 
it  in  its  present  form,  will  derive  a  fund  of  practical  in- 
formation from  it  that  will  not  only  be  of  direct  value, 
but  will  give  them  a  better  understanding  and  appreciation 
of  the  basic  principles  of  three  essentials  of  business  suc- 
cess— good  judgment,  legal  knowledge,  and  an  under- 
standing of  human  nature. 

NEWMAN  ESSICK 
May  i,  1914 


CONTENTS 


CHAPTER  PAGE 

I     SYSTEM  AND  EFFICIENCY  IN  THE  CREDIT  DEPARTMENT    .        .        7 

By  M.  Martin  Kallman,  Efficiency  Expert;  President  Ma- 
comber  Motors  Co. 

II     CREDIT  DEPARTMENT  METHODS 20 

By  Alfred  K.  Care,  Credit  Manager  Cudahy  Packing  Co. 

III  BANK  CREDITS  50 

By  J.   M.  Elliott,   President  First   National  Bank  of  Los 
Angeles. 

IV  FINANCIAL  STATEMENTS,  THEIR  FORM  AND  ANALYSIS    .        .      64 
By  Herman  Flatau,  Secretary  M.  A.  Newmark  &  Co. 

V    COMMERCIAL  AGENCIES  AND  REPORTS  ....      87 

By  E.  R.  Purdy,  Superintendent  Los  Angeles  Office,  Brad- 
street  Co. 

VI    CREDITS  AND  COLLECTIONS 102 

By  C.  A.  Parmalee,  Vice- President  Parmalee-Dohrmann  Co. 

VII    AUDITS  AND  INVESTIGATIONS 118 

By  W.  C.  Mushet,  C.P.A.,  Secretary  Los  Angeles  Credit 
Men's  Association;  President  Mushet  Audit  Co. 


vi  CONTENTS 

CHAPTER  PAGE 

VIII    LIENS  ON  PERSONAL  PROPERTY 136 

By  N.  P.  Conrey,  Judge  of  the  Superior  Court  for  Los 
Angeles  County. 

\ 
IX    LIENS  ON  REAL  ESTATE 159 

By  Hon.  Lee  C.  Gates,  of  the  California  State  Senate,  Chief 
Counsel  for  the  Title  Insurance  and  Trust  Co. 


X    FRAUDS 179 

By  W.  J.  Ford,  Assistant  District  Attorney  for  Los  Angeles 
County. 


XI    AMICABLE  ADJUSTMENT  WITH  INSOLVENT  DEBTORS        .        .    196 

By  F.  C.  DeLano,  Secretary  for  the  Los  Angeles  Whole- 
salers Board  of  Trade. 


XII    BANKRUPTCY .    223 

By  W.  T.  Craig,  Ph.B.,  Attorney  for  the  Los  Angeles 
Wholesalers  Board  of  Trade,  Lecturer  on  Bankruptcy  in 
Law  Department  of  the  University  of  Southern  California. 


XIII    INSURANCE  IN  COMMERCIAL  AFFAIRS 246 

By  Warren  C.  Kennedy,  Secretary  Baker  Iron  Works; 
Treasurer  California  Iron  Works;  Vice-President  Chamber 
of  Mines  and  Oil ;  ex-President  Los  Angeles  Credit  Men's 
Association. 


XIV    CORPORATIONS 265 

By  Frank  G.  Finlayson,  Judge  of  the  Superior  Court  for 
Los  Angeles  County. 


Mercantile  Credits 


CHAPTER  I 

SYSTEM  AND  EFFICIENCY  IN  THE  CREDIT 
DEPARTMENT* 

BY  M.  MARTIN  KALLMAN 

Importance  of  the  Credit  Man's  Position 

Credit  is  the  basis  upon  which  commerce  and  nations 
subsist;  or,  to  put  it  another  way,  credit  is  the  foundation 
upon  which  business  is  built — upon  which  its  very  exist- 
ence is  dependent.  This  being  so,  it  is  interesting  to  in- 
quire what  sort  of  men  bear  the  responsibility  of  granting 
or  refusing  credits.  We  shall  find  them  in  widely  varying 
positions.  Sometimes  the  credit  man  is  a  partner  in  the 
firm,  sometimes  a  salesman,  oftentimes  merely  a  book- 
keeper. But  whatever  his  rank,  the  results  of  his  work 
are  equally  important. 

No  one  is  in  a  better  position  than  the  professional 
business  systematizer  to  know  how  much  is  demanded  of 
the  credit  man;  for  the  credit  desk  is  the  first  place  to 
which  he  is  conducted  when  he  begins  an  engagement.  He 
is  first  taken  there  because  the  credit  man  is  supposed  to 

*  By  permission  of  Mr.  Kallman. 


8'  '  MERCANTILE  CREDITS 

know  something  about  everything  upon  which  the  other 
officials  of  the  establishment  are  not  compelled  to  be 
informed. 

The  Credit  Man's  Routine 

Whatever  the  house  has  in  the  way  of  an  accounting 
system  is  generally  the  work  of  the  credit  man,  and  though 
the  result  is  not  always  deserving  of  unqualified  praise, 
the  fact  still  remains  that  upon  his  shoulders  has  fallen 
the  burden  of  meeting  the  requirements  of  accounting 
progress.  Again,  if  a  blank  or  a  special  form  is  needed 
in  any  department,  the  task  of  drawing  it  up  usually  falls 
to  the  man  at  the  credit  desk.  Then,  too,  the  larger  prob- 
lems of  house  finance  are  almost  invariably  submitted  to 
him.  Quite  frequently,  indeed,  the  credit  man  is  the  ac- 
tive financial  head  of  the  house.  Again,  particularly  in 
small  houses,  he  is  often  charged  with  the  buying  of  the 
house  stationery  and  numerous  petty  details  of  a  similar 
nature,  which,  in  addition  to  his  main  routine  duties,  make 
him  the  most  overworked  member  of  the  house  staff. 

Yet  the  credit  man  needs,  more  perhaps  than  any  other 
official,  to  have  the  advantage  of  that  liberation  from  the 
slavery  of  petty  details  which  it  is  the  mission  of  modern 
business  system  to  bring.  If  any  man  in  the  organization 
of  the  modern  business  house  should  have  time  in  which 
to  think,  and  to  think  without  interruption  or  annoyance, 
it  is  the  credit  man.  The  poorest  possible  economy  in 
which  an  establishment  can  indulge  is  that  of  so  crowding 
the  man  at  the  credit  desk  that  he  has  to  work  his  pencil 
more  than  his  brains. 

The  Duty  of  the  Credit  Man 

The  credit  man  really  earns  his  money  by  the  skill 
with  which  he  handles  a  comparatively  small  percentage 


EFFICIENCY  IN  CREDIT  DEPARTMENT          9 

of  the  total  number  of  accounts  under  his  care.  In  mak- 
ing this  statement  I  have  little  fear  of  contradiction.  Let 
us  say,  for  example,  that  at  least  90  per  cent  of  the  ac- 
counts passed  upon  by  the  credit  man  of  average  experi- 
ence and  ability  are  sound  and,  broadly  speaking,  above 
suspicion.  Then  the  real  value  of  his  services  to  the 
house  rests  upon  the  judgment  and  diplomacy  with  which 
he  passes  upon  the  remaining  10  per  cent  of  accounts 
which  cannot  quite  meet  the  standard  set  up  for  Caesar's 
wife. 

System  as  an  Aid  to  Efficiency 

It  will  require  no  unusual  acumen  to  see  that,  if  the 
task  of  scrutinizing  the  90  per  cent  of  sound  accounts  can 
be  reduced  to  so  small  a  minimum  as  to  demand  com- 
paratively little  of  the  credit  man's  attention,  both  he  and 
his  house  will  be  immensely  the  gainer,  as  he  will  have  far 
more  time  and  energy  to  devote  to  those  accounts  which 
really  call  for  the  exercise  of  his  best  energy,  judgment, 
and  protective  powers.  This  is  only  another  way  of  say- 
ing that  the  traditional  routine  duty  of  passing  upon  the 
90  per  cent  of  solid  accounts  has  often  compelled  the 
credit  man  to  treat  the  dubious  10  per  cent  in  a  hasty  and 
perfunctory  fashion,  and  occasionally  to  commit  errors 
which  have  had  serious  consequences. 

How  shall  the  conditions  be  so  readjusted  as  to  permit 
the  credit  man  to  concentrate  practically  all  of  his  atten- 
tion upon  the  doubtful  10  per  cent  of  accounts,  knowing 
that  the  substantial  90  per  cent  is  being  adequately  cared 
for  and  protected  without  his  constant  and  specific  atten- 
tion? System  alone  can  solve  this  problem — system 
which  "flags"  orders  on  any  account  in  the  least  degree 
doubtful,  and  at  the  same  time  allows  the  right  of  way  to 
all  orders  on  accounts  in  a  proper  condition. 


io  MERCANTILE  CREDITS 

In  other  words,  a  right  method  makes  it  possible  for 
any  member  of  the  credit  department  having  the  intelli- 
gence of  an  ordinary  clerk  to  pass  upon  the  credit  of  cus- 
tomers obviously  in  condition  to  take  care  of  their  orders. 
At  the  same  time,  it  makes  it  impossible  for  a  single  ex- 
tension of  credit  to  be  made  on  any  account  not  deserv- 
ing it. 

Operation  of  a.  Credit  System 

By  way  of  illustration,  let  us  suppose  that  the  credit 
man  of  Merchant  &  Company  goes  out  to  luncheon  and 
meets  his  friend  from  down  the  street,  whose  house  sells 
goods  to  many  of  the  customers  of  Merchant  &  Company. 
This  friend  inquires :  "Do  you  sell  Jones,  of  San  Diego  ?" 

"Yes,"  answers  our  credit  man,  "he  has  a  very  good 
line  with  us." 

"Well,"  responds  the  friend,  "that  may  be  all  right, 
but  I  have  just  heard  from  a  reliable  neighbor  of  his  that 
he  has  been  speculating  rather  freely  of  late,  and  is  be- 
lieved to  have  suffered  severe  losses;  in  fact,  my  informant 
declares  that  he  is  pretty  deep  in  the  hole,  and  that  he  is 
likely  to  have  a  rather  hard  time  of  it  for  several  months 
to  come.  Very  likely,  though,  he  will  be  able  to  pull 
through  all  right,  unless  some  of  his  creditors  or  backers 
get  scared  and  begin  to  shut  down  heavy  on  him." 

Now,  if  the  credit  man  of  Merchant  &  Company  has 
his  office  organized  under  a  right  system,  the  first  thing  he 
does  after  he  has  returned  to  the  office  and  hung  up  his 
coat  and  hat,  is  to  take  from  the  card  record  of  house 
customers  the  particular  card  bearing  the  name  of  Jones, 
of  San  Diego.  On  this  he  pencils  his  own  initials.  This 
initialling  is  a  signal  which  automatically  stops  all  orders 
and  transactions,  and  immediately  refers  them  to  his  per- 
sonal attention.  Every  employee  of  the  office  knows  that 
to  allow  an  order  to  pass  this  signal  without  being  specifi- 


EFFICIENCY  IN  CREDIT  DEPARTMENT        n 

cally  referred  to  the  credit  man,  is  to  violate  a  cardinal 
rule  of  the  house,  and  to  incur  a  severe  penalty. 

But  this  is  not  all.  In  an  appropriate  space  on  the 
card  which  bears  the  record  of  all  the  transactions  of 
Jones  with  the  house,  he  notes  the  reason  for  such  sum- 
mary action  in  altering  the  line  of  credit  which  the  cus- 
tomer has  previously  enjoyed.  The  card  then  shows  a 
complete  statement  of  the  conditions. 

On  the  other  hand,  let  us  suppose  that  this  credit  man 
is  a  representative  of  the  old  school.  He  prides  himself 
upon  his  ability  to  carry  "under  his  hat"  the  key  to  the 
credit  of  his  customers;  and,  so  far  as  his  written  records 
are  concerned,  there  is  no  change  in  the  standing  which 
Jones,  of  San  Diego,  enjoys  with  the  house. 

The  credit  man  of  the  old  school  knows  that  he  is  go- 
ing to  tighten  the  line  so  far  as  Jones  is  concerned,  and  he 
feels  that  it  is  enough  that  he  knows  it.  But  it  happens 
that  our  credit  man  suffers  from  an  attack  of  indigestion 
a  day  or  two  later  and  is  compelled  to  stay  at  home  to 
recuperate.  If  he  has  an  assistant,  he  has  forgotten  to 
tell  him  the  story  of  what  happened  to  Jones  in  the  ups 
and  downs  of  the  market — for  credit  men  sometimes  do 
forget.  While  our  old-style  credit  man  is  dieting  at  home, 
Jones  sends  in  an  uncommonly  heavy  order.  There  is  not 
a  scratch  of  a  pencil,  or  a  black  mark  of  any  kind,  against 
his  name;  and  consequently  the  order  goes  through,  the 
goods  are  shipped,  and  by  the  time  the  chief  of  the  credit 
department  is  convalescent  and  back  at  his  desk,  Jones, 
of  San  Diego,  is  a  successful  bankrupt  and  the  house  is 
the  loser. 

Instances  of  this  kind,  as  every  credit  man  knows,  are 
happening  every  day;  but  they  cannot  occur  in  any  estab- 
lishment where  a  credit  department  is  operated  under  an 
adequate  and  thoroughly  modern  system. 


12  MERCANTILE  CREDITS 

Result  of  Lack  of  System 

One  of  the  most  marvelous  things  in  the  history  of 
merchandising  is  the  amount  of  dearly  bought  experience 
required  to  teach  the  average  business  man  that  his  "Cus- 
tomers Ledger"  is  not  an  inspired  volume  invested  with 
miraculous  infallibility,  and  that  the  credit  man  who  car- 
ries his  knowledge  of  his  customers  "under  his  hat"  is, 
sooner  or  later,  bound  to  have  his  hat  and  all  that  is  under 
it  in  the  wrong  place  at  the  critical  moment — a  fact  which 
makes  him  a  mighty  poor  and  inadequate  supplement  to 
the  customers  ledger. 

Some  years  ago,  when  the  bicycle  habit  was  at  its 
height,  the  half-owner  and  credit  man  of  a  big  Eastern 
jobbing  house  was  called  from  his  desk  to  attend  the 
funeral  of  a  friend.  While  returning  from  this  sad  mission 
he  chanced  to  be  in  the  same  conveyance  with  an  acquaint- 
ance from  a  smaller  city  in  a  neighboring  state.  This 
friend  asked:  "Does  Mr.  Blank,  of  my  town,  still  deal 
with  you?"  "Yes,"  was  the  answer,  "we  sell  him  a  big 
line  of  goods;  in  fact,  his  business  is  increasing  right 
along,  and  he  is  among  our  best  customers." 

"Well,  I  like  him  all  right,"  replied  the  friend,  "but  I 
happened  to  learn  something  yesterday  which  I  feel  in 
duty  bound  to  tell  you.  As  yet  it  is  little  known,  but  I 
can  vouch  for  the  fact  that  he  is  transferring  his  real 
estate  holdings  to  his  wife.  This,  to  my  notion,  means 
that  he  is  fixing  for  a  first-class  failure  and  that  you  will 
do  well  to  get  from  under." 

When  this  credit  man  returned  to  the  office  he  punctil- 
iously consulted  the  ledger  and  looked  at  the  account  of 
this  particular  customer;  but  the  ledger  showed  that  Mr. 
Blank  had  recently  remitted  a  sum  which  balanced  the 
account. 

The  other  partner  of  the  house  had  exclusive  control 


EFFICIENCY  IN  CREDIT  DEPARTMENT        13 

of  the  merchandising  and  selling  end  of  the  concern,  but 
never  ventured  to  interfere  with  the  affairs  of  the  credit 
department,  nor  did  he  permit  his  associate  to  interfere 
with  his  own  branch  of  the  business. 

Now,  while  the  credit  man  was  absent  attending  the 
funeral,  Mr.  Blank  had  called  at  the  establishment  and 
personally  placed  an  order  for  several  hundred  bicycles. 
Of  course,  the  partner  at  the  head  of  the  selling  depart- 
ment consulted  the  ledger  and  found  his  customer's  ac- 
count in  excellent  condition.  The  order  was  put  through 
and  the  goods  shipped  in  haste,  in  accordance  with  the 
special  instructions  left  by  the  visiting  customer. 

The  day  following  the  funeral  which  the  credit  man 
had  attended,  the  merchandising  partner  was  called  out  of 
the  city  and  did  not  return  for  several  days.  As  a  result, 
before  the  big  order  for  wheels  was  posted  on  the  ledger 
and  came  under  the  eye  of  the  credit  department  chief, 
the  shipment  had  been  received  by  Mr.  Blank,  disbursed, 
and  that  enterprising  retailer  had  gone  into  bankruptcy. 

Scores  of  other  incidents  along  this  line  might  be 
cited,  all  emphasizing  as  pointedly  as  this  the  moral: 
"Customers  ledgers  are  not  sacredly  infallible  guides" — 
and  the  further  fact  that  the  credit  man  who  carries  his 
information  under  his  hat  is  as  useless  to  his  house  at 
times  as  he  will  be  eventually  when  there  is  crepe  on  its 
door  and  the  partners  and  heads  of  department  are  at- 
tending his  funeral.  This  kind  of  a  credit  man  leaves  his 
money  behind  him,  but  his  information  dies  with  him,  and 
all  the  ledgers  in  the  world  will  not  save  it — particularly 
if  there  is  a  few  days'  delay  in  the  matter  of  posting,  as  is 
likely  to  be  the  case  in  a  house  where  so  little  of  modern 
system  obtains. 

Perhaps  you  are  inclined  to  ask  how  this  disaster  could 
have  been  prevented  under  the  operation  of  an  up-to-date 


I4  MERCANTILE  CREDITS 

system.  Just  as  soon  as  the  customer  came  into  the  house 
and  made  application  for  so  large  a  draft  upon  his  credit, 
someone  from  the  selling  department  should  have  quietly 
visited  the  credit  desk.  Finding  the  credit  partner  absent, 
and  failing  to  find  any  specific  data,  aside  from  a  clear 
balance  on  the  ledger,  he  would  have  drawn  the  card  of 
Mr.  Blank  from  the  record  and  placed  it  upon  the  credit 
man's  desk,  together  with  a  memorandum  of  the  order. 
Immediately  upon  the  return  of  the  credit  man  this  in- 
formation would  have  been  forced  upon  his  attention  and, 
as  a  result,  the  shipment  of  the  goods  would  have  been 
stopped. 

System  as  an  Aid  to  the  Salesman 

Another  practice  common  in  poorly  organized  busi- 
ness houses  is  that  of  encouraging  customers  to  buy  their 
goods  before  the  house  definitely  determines  whether,  un- 
der existing  circumstances,  the  invoice  involves  a  larger 
line  of  credit  than  it  desires  to  extend.  For  example,  a  cus- 
tomer comes  into  the  wholesale  house  and  spends  half  a 
day  in  buying  a  large  bill  of  goods.  This  also  involves 
half  a  day's  time  on  the  part  of  the  salesman.  After  he  is 
all  through  selecting  his  goods,  the  order  gets  up  to  the 
credit  desk,  and  it  is  discovered  that  the  customer's  ac- 
count is  not  in  condition  to  warrant  the  new  bill.  Then, 
after  the  customer  and  the  salesman  have  both  wasted 
their  time,  the  buyer  is  told  that  his  line  of  credit  will  not 
stand  the  additional  strain  of  the  amount  involved  in  his 
purchase.  Naturally,  this  causes  disappointment  and 
makes  bad  blood.  Very  often,  too,  it  results  in  the  per- 
manent alienation  of  a  good  patron  of  the  house. 

If  a  proper  system  is  enforced,  the  first  thing  in  order 
when  a  customer  enters  the  house  and  signifies  his  inten- 
tion of  buying,  is  to  send  to  the  credit  department  records 


EFFICIENCY  IN  CREDIT  DEPARTMENT        15 

and  get  his  number.  This  at  once  tells  the  employee  or 
salesman  precisely  the  line  of  credit  to  which  he  is  entitled. 
Thus  forewarned,  the  salesman  is  in  a  position  of  ad- 
vantage, and  by  the  exercise  of  a  little  diplomacy — the 
giving  of  a  little  sound  advice  regarding  the  extent  of  the 
customer's  purchases — he  is  able  to  keep  the  order  within 
the  proper  credit  limit,  thus  avoiding  disappointment, 
waste  of  time,  and  perhaps  the  permanent  loss  of  a  cus- 
tomer. It  is  a  safe  rule  that  the  house  salesman  should 
learn  the  exact  amount  of  credit  to  which  the  customer  is 
entitled  before  he  begins  the  actual  process  of  taking  that 
patron's  order.  And  this  can  always  be  done  without  the 
customer's  knowing  that  the  salesman  has  this  informa- 
tion. 

Advantages  of  Personal  Contact 

As  the  present  chapter  is  intended  to  offer  practical 
and  helpful  credit  suggestions,  I  shall  not  hesitate  to  in- 
dulge in  a  word  of  criticism.  One  of  the  most  serious 
weaknesses  of  the  average  credit  department  is  found  in 
the  comparatively  slight  personal  intercourse  between  the 
credit  man  and  his  customers.  To  a  very  large  extent 
their  communications  are  not  only  written,  but  of  a 
formal,  cut-and-dried  nature.  While  it  is  true  that  the 
credit  man  does  see  certain  of  his  customers  quite  fre- 
quently, it  is  equally  true  that  he  has  no  personal  acquaint- 
ance at  all  with  a  very  large  portion  of  them.  The  cause 
of  this  condition  has  already  been  indicated.  The  head 
of  the  credit  department  is  tied  down  to  his  desk  by  an 
elaborate  network  of  details  which,  under  an  adequate 
system,  are  safely  and  expeditiously  taken  care  of  by  inex- 
pensive help. 

It  is  my  conviction  that  every  credit  man  should  come 
into  personal  contact  with  each  one  of  his  customers  at 


1 6  MERCANTILE  CREDITS 

least  once  a  year,  and  oftener  if  possible.  And  the  right 
sort  of  a  system  will  make  it  possible  for  each  customer  of 
a  house  to  be  personally  seen  once  a  year  by  some  person 
in  a  position  of  authority  in  the  credit  department.  If 
Mahomet  will  not  visit  the  mountain,  let  the  mountain 
visit  Mahomet.  When  the  customer  cannot  be  induced  to 
call  upon  the  credit  man,  let  the  credit  man  call  upon  the 
customer.  In  no  department  of  business  does  the  per- 
sonal equation  have  greater  weight  than  in  the  credit  de- 
partment; and  it  is  absolutely  impossible  for  the  personal 
equation  to  be  accurately  determined  except  by  personal 
contact. 

The  Credit  Man  as  a  Selling  Factor 

Another  conclusion  which  has  been  forced  upon  me  is 
that,  generally  speaking,  the  credit  man  does  not  realize 
his  power  as  an  active  selling  factor.  He  is  in  the  habit 
of  thinking  of  the  credit  department  as  purely  protective 
instead  of  as  a  possible  productive  factor.  His  relation 
to  the  effort  of  the  house  to  make  more  sales  should  be  as 
constantly  in  his  mind  as  the  effort  to  see  that  the  sales 
actually  made  are  safe.  Very  few  letters  should  go  out 
of  the  credit  department  without  containing  some  refer- 
ence to  more  orders  or  further  orders  from  the  customers. 
The  credit  man  should  know  at  once  when  the  purchases 
of  any  good  customer  are  falling  off,  and  should  take  steps 
to  learn  the  reason  for  this  change.  Of  course,  this  must 
be  done  with  tact — but  tact  and  judgment  are  two  neces- 
sary qualifications  of  the  credit  man. 

The  Credit  System  as  a  Character  Record 

A  good  credit  system  is  so  sensitive  that  it  indicates, 
with  automatic  precision,  the  character  of  the  customer. 
Toy  do  not  need  to  be  told  that  kicks  and  complaints 


EFFICIENCY  IN  CREDIT  DEPARTMENT        17 

the  favorite  weapons  of  customers  who  believe  that  they 
have  some  advantage  to  gain  by  sharp  practice  with  the 
house  from  which  they  get  their  goods.  It  does  not  gen- 
erally occur  to  such  a  customer  that  the  house  will  remem- 
ber that  he  has  registered  a  kick  a  month  ago;  but  the 
little  card  bearing  his  record  indicates  at  a  glance  every 
time  a  complaint  was  entered. 

Let  us  suppose  that  a  new  customer  sends  in  his  first 
complaint.  Under  the  right  kind  of  a  system  this  is  im- 
mediately indicated  on  his  card  record.  At  once  instruc- 
tions are  sent  out  through  the  house  to  double-check  his 
next  shipment,  and  to  exercise  especial  care  in  every  detail 
relating  to  it,  even  to  seeing  that  the  packing  of  the  goods 
is  done  in  a  manner  beyond  criticism.  If  this  customer 
enters  another  complaint  next  month,  he  is  then  considered 
a  subject  of  suspicion,  is  placed  under  surveillance,  and  a 
special  effort  is  made  to  arrive  at  his  motive  for  the  com- 
plaint. In  the  same  manner  the  good  system  takes  care 
of  the  matter  of  slow  pay  and  of  all  other  elements  enter- 
ing into  the  customer's  relationship  with  the  house. 

Proper  Use  of  the  Mercantile" Agency 

A  frequent  element  of  weakness  in  credit  departments 
is  the  too  implicit  reliance  upon  mercantile  agency  ratings 
and  reports.  Do  not  understand  me  as  attempting  to 
minimize  the  great  value  and  usefulness  of  the  agencies. 
They  are  an  absolute  necessity  for  the  safe  conduct  of 
business  under  the  complex  conditions  of  our  modern 
commercial  life.  On  the  other  hand,  you  will  hardly 
question  the  statement  that  they  are  the  crutch  upon 
which  both  the  weak  customer  and  the  weak  credit  man 
are  inclined  to  lean  too  heavily. 

The  country  merchant  who  is  not  financially  as  strong 
or  as  sound  as  he  would  like  to  be,  takes  especial  pains 


1 8  MERCANTILE  CREDITS 

and  goes  to  any  length  to  build  up  his  ratings  in  the  com- 
mercial agencies,  while  the  credit  man  who  is  either  timid 
or  inexperienced,  and  who  has  not  the  advantage  of  a  sys- 
tem which  stores  accurate  and  available  information  re- 
garding all  his  customers,  is  disposed  to  base  too  many 
of  his  decisions  upon  the  reports  of  the  agency.  In  doing 
this  he  is  sometimes  in  danger  of  giving  too  short  a  line 
of  credit.  Many  a  house  organized  on  a  small  capitaliza- 
tion does  not  show  all  of  its  strength  in  its  statements  to 
the  commercial  agency,  for  the  very  good  reason  that  as- 
sessors and  tax-raising  bodies,  as  well  as  merchants,  have 
access  to  agency  information  and  know  how  to  use  this 
information  to  the  increase  of  the  tax  returns.  For  ex- 
ample, a  certain  Eastern  house,  capitalized  and  rated  at 
$100,000,  actually  does  a  business  of  more  than  a  million 
dollars  a  year.  It  is  scarcely  reasonable  to  suppose  that 
so  large  a  business  as  this  is  done  upon  so  small  a  capital 
as  that  represented  by  the  rating  of  the  house  in  the  mer- 
cantile agency  report.  There  are  many  other  reasons 
why  the  credit  man  should  be  in  a  position  to  render  his 
judgments  practically  independent  of  the  agency  reports, 
or  at  least  to  use  them  by  way  of  verification.  And  this 
he  cannot  do  unless  he  has  a  system  which  provides  the 
right  information  and  crystallizes  it  into  permanent  office 
records  in  such  a  manner  that  it  is  instantly — almost  auto- 
matically— ready  for  application  to  every  case  and  every 
customer. 

Results  of  System 

These  hints  will  be  sufficient  to  show  how  a  thor- 
oughly modern  system  in  the  merchandising  house,  and 
especially  in  its  credit  department,  makes  it  possible  for 
the  credit  man  to  concentrate  practically  his  whole  atten- 
tion upon  the  matters  which  need  his  attention,  instead  of 


EFFICIENCY  IN  CREDIT  DEPARTMENT         19 

squandering  his  time  and  energies  upon  a  mass  of  details 
which  daily  pass  over  his  desk  simply  because  long  usage 
and  tradition  so  decree.  By  taking  advantage  of  the 
economy  wrought  by  well-devised  modern  office  methods, 
any  credit  man  can  enormously  increase  the  power  and  in- 
fluence which  he  exerts  in  the  house  organization,  giving 
his  best  efforts  only  to  those  matters  which  are  really 
worthy  of  them. 

That  the  proper  systematization  of  the  operations  of 
the  credit  department  will  effect  a  much-desired  economy 
of  the  time,  labor,  and  energy  of  the  credit  man  is  a 
truism ;  but  to  what  extent  system  will  be  made  an  accom- 
plished fact  in  connection  with  credit  work  is  very  largely 
dependent  upon  the  interest  the  credit  man  exhibits  in  this 
subject.  If  he  advocates  such  a  policy,  and  adopts  and 
promulgates  the  forms  and  methods  required  to  carry  it 
into  effect,  half  the  battle  is  won.  Of  course,  individual 
systems  will  differ  according  to  individual  needs,  but  it  is 
greatly  to  be  desired  that  certain  forms  should  be  pre- 
pared for  general  use,  and  certain  uniform  lines  of  action 
adopted,  with  a  view  to  liberating  the  credit  man  from 
slavery  to  details,  and  leaving  him  free  to  make  his  indi- 
viduality the  power  that  it  should  be  in  the  house  organi- 
zation. 


CHAPTER  II 

CREDIT  DEPARTMENT  METHODS 
BY  ALFRED  K.  CARE 

Importance  of  Credit  Methods 

Factory  methods,  sales  methods,  and  accounting 
methods  are  now  made  the  subject  of  careful  study  by  the 
up-to-date  manufacturer  and  merchant.  Credit  depart- 
ment methods  are  surely  of  equal  importance.  In  fact, 
the  success  of  a  business  house  depends  largely  on  the 
wisdom,  judgment,  and  courage  of  its  credit  man,  and  the 
methods  adopted  by  the  credit  man  are  what  he  depends 
upon  to  bring  results. 

Confidence  is  the  basis  upon  which  the  whole  business 
structure  rests,  for  in  order  to  carry  on  business  at  all, 
men  must  trust  one  another.  Bank  notes  and  greenbacks, 
popularly  called  money,  are  merely  promises  to  pay;  and 
their  acceptance  is  an  expression  of  confidence  in  the  abil- 
ity and  willingness  of  the  government  to  pay  their  face 
value  on  demand. 

Unfortunately,  however,  confidence  is  sometimes  mis- 
placed; and  in  the  past  we  have  often  been  too  liberal  in 
the  extension  of  credit.  Sufficiently  close  investigation  of 
the  applicant  for  credit  has  frequently  been  neglected,  and 
this  neglect  has  led  to  many  business  failures.  The  im- 
proved methods,  now  being  adopted  by  credit  men,  are 
greatly  reducing  the  losses  of  their  respective  houses, 
which  are  thus  enabled  to  meet  competition  with  more 

20 


CREDIT  DEPARTMENT  METHODS  21 

success  and  to  do  better  by  their  customers.    It  is  obvious 
that  these  methods  are  worthy  of  careful  study. 

Cooperation  with  the  Sales  Department 

One  of  the  first  points  in  the  consideration  of  credit 
department  methods  is  the  relation  between  the  credit 
department  and  the  sales  department,  which  in  the  past 
have  not  always  worked  together  harmoniously.  The 
desire  to  sell  goods  is  uppermost  in  the  mind  of  the  sales 
department,  and  too  frequently  the  conservatism  of  the 
credit  man  is  overruled  by  the  head  of  the  house  in  his 
desire  not  to  lose  business  which  a  competitor  may  take 
over.  In  more  recent  years,  however,  the  credit  man  has 
been  given  greater  authority;  and  in  most  business  houses 
of  today,  his  decision  is  final.  He  has  achieved  this  rec- 
ognition by  careful  study  of  his  subject,  and  by  adopting 
various  methods  to  get  all  the  information  possible,  not 
only  as  to  prospective  customers  but  as  to  those  who  may 
have  been  on  the  books  of  the  firm  for  many  years, 
thereby  placing  himself  in  close  touch  with  the  financial 
condition  of  all  the  clients  of  his  house.  It  is  this  positive 
knowledge  which  gives  weight  to  his  opinions. 

Work  of  the  Credit  Man 

The  first  duty  of  the  credit  man  is  to  obtain  all  the  in- 
formation possible  regarding  the  applicant  for  credit;  the 
second,  to  analyze  the  information  obtained — and  here  is 
where  his  experience,  ability,  and  judgment  are  brought 
into  full  play.  He  should  be  an  accountant,  or  at  least 
should  have  sufficient  knowledge  of  accountancy  to  be  able 
to  analyze  intelligently  a  customer's  financial  statement. 
At  times  he  may  even  be  required  to  inspect  a  customer's 
books  and  draw  off  a  statement;  and  without  a  knowledge 
of  accounting  this  would  be  impossible. 


22 


MERCANTILE  CREDITS 


Gathering  Credit  Information 

The  credit  man  cannot  obtain  too  much  information 
regarding  his  customer,  and  he  should  instil  into  the 
minds  of  his  salesmen  the  desirability  of  informing  him 
of  every  circumstance  affecting  the  customer,  whether  it 
be  favorable  or  unfavorable.  Every  salesman  should  be 
required  to  carry  a  block  of  forms  similar  to  those  shown 
below,  one  of  which  is  filled  out  for  each  new  customer. 
The  salesman  is  not  expected  to  ask  the  customer  any  of 
the  questions  on  the  form,  but  to  obtain  the  information 
in  the  course  of  conversation  with  him  or  others.  All 
this  information  is  properly  noted  and  filed  with  the 
records. 


Ill 


;      J       «      -f 
:       v       °       S 


•S«-  J  £ 

ill  -2^  1 

||l|l  | 

^£5     ^.G  O 


Salesman's  Report  on  New  Customer  (First  Form) 


The  first  question  after  name  and  address,  is  "How 
long  in  business  ?"  Now,  the  question  of  experience  is  an 
important  one,  as  the  length  of  time  a  man  has  been  in 
business  or  has  worked  for  others,  enables  one  to  gauge 
his  ability  to  some  extent. 


CREDIT  DEPARTMENT  METHODS  23 

Another  very  important  question — as  to  the  value  of 
stock — is  easily  answered  according  to  information  ob- 
tained from  the  man  himself,  confirmed  or  corrected  by 
the  estimate  of  the  salesman,  who  ordinarily  is  a  good 
judge.  The  condition  of  the  stock  is  open  to  observation. 
The  name  of  the  customer's  banker  and  names  of  firms 
buying  from  him  are  also  readily  obtained.  When  we 
come  to  the  question,  "What  amount  of  credit  do  you 
recommend?"  the  salesman  should  be  in  a  position  to 
answer  with  assurance ;  and  my  experience  has  been  that 
as  a  rule  he  is  fairly  conservative  in  his  views. 


W 

I 


Salesman's  Report  on  New  Customer  (Second  Form) 


Commercial  Agency  Reports 

The  salesman's  report  is  sent  in  with  an  order,  we  will 
say  from  John  Smith,  Lansing,  California,  and  duly 
reaches  the  credit  department,  which  at  once  proceeds  to 
gather  all  the  information  it  can  with  reference  to  John 
Smith.  Here  we  discover  the  usefulness  of  commercial 


24  MERCANTILE  CREDITS 

agencies  such  as  Bradstreet's  and  R.  G.  Dun  &  Co.  An 
inquiry  is  made  of  one  of  these  agencies — possibly  both — 
for  a  report  on  John  Smith,  Lansing,  California.  When 
it  is  received,  you  find  that  according  to  Smith's  own  state- 
ment he  is  married,  and  therefore  can  exempt  real  estate 
to  the  extent  of  $5,000  in  that  state;  that  he  has  a  stock 
of  $10,000;  outstanding  accounts,  $3,000;  fixtures, 
horses,  wagons,  etc.,  $2,500;  cash,  $500;  real  estate, 
$2,000  clear  of  encumbrance;  homestead,  $3,000;  and  in- 
surance for  $8,000.  His  liabilities  consist  of  trade  in- 
debtedness, $4,500;  indebtedness  to  bank,  $1,500;  other 
borrowed  money,  $2,000;  and  he  considers  himself  worth 
$10,000  over  and  above  all  debts  and  exemptions.  The 
report  then  proceeds  to  give  the  result  of  the  agency's 
investigation  of  his  statement,  which  is  practically  con- 
firmed; it  also  states  that  the  various  houses  interviewed 
report  him  prompt  in  his  payments,  and  that  he  is  reck- 
oned, from  the  standpoint  of  credit,  at  an  estimated  net 
worth  of  $5,000  to  $8,000.  All  of  this  being  favorable  to 
Mr.  Smith,  his  order  is  OK'd  for  credit. 

Other  Sources  of  Information 

Those  unfamiliar  with  credit  work  will  say,  "Why, 
how  easy!"  and  it  certainly  would  be  easy  if  Mr.  Smith's 
case  were  a  fair  sample.  But,  unfortunately  for  the  credit 
man,  when  he  most  desires  quick  information  on  his  cus- 
tomer, the  agency  is  without  any,  or  what  it  has  is  of  little 
value.  On  the  other  hand,  he  may  receive  the  information 
that  Mr.  Smith's  statement  is  not  confirmed,  that  his  in- 
debtedness is  much  greater  than  he  states,  and  that  his 
payments  are  very  unsatisfactory,  which  is  certainly  valu- 
able information.  However,  we  need  not  depend  entirely 
upon  the  agency  report.  Our  salesman  has  furnished  us 
with  the  name  of  Mr.  Smith's  bank,  and  those  of  the  prin- 


CREDIT  DEPARTMENT  METHODS  25 

cipal  firms  from  which  he  is  buying;  and  we  have  com- 
municated with  these  parties  either  by  telephone  or  letter, 
the  result  being  favorable  or  otherwise,  as  the  case  may  be. 
A  commonly  used  form  of  credit  information  letter  is  as 
shown  on  page  26. 

If  the  information  is  not  entirely  favorable,  we  im- 
mediately write  Mr.  Smith,  thanking  him  for  his  order 
and  asking  him  for  a  financial  statement  and  for  refer- 
ences, basing  our  request  on  the  fact  that  he  is  a  stranger 
to  us.  And  if  Mr.  Smith  furnishes  us  with  a  signed  state- 
ment of  his  financial  condition  (even  though  the  outside 
information  may  not  be  quite  as  favorable  as  we  could 
desire),  we  are  inclined  to  grant  him  a  line  of  credit,  for 
the  reason  that  he  would,  under  certain  conditions,  be 
criminally  liable  if  he  made  a  false  statement. 

In  the  first  case  we  apparently  took  no  risk  in  granting 
Mr.  Smith  credit;  in  the  second  case,  there  was  an  element 
of  risk  which  we  partially  overcame  by  obtaining  the  finan- 
cial statement.  By  keeping  in  close  touch  with  Mr.  Smith's 
condition  at  all  times,  we  could  possibly  continue  to  grant 
a  line  of  credit  with  safety. 

It  must  be  remembered,  however,  that  credit  is  not 
always  based  solely  on  a  man's  assets.  Often  credit  is 
extended  largely  on  the  known  honesty  and  integrity  of  the 
customer,  and  on  the  knowledge  or  belief  that  he  would 
not  incur  a  debt  he  did  not  see  his  way  clear  to  pay  when 
due.  This  is  the  moral  risk,  and  the  credit  man  must 
depend  on  his  own  judgment  to  handle  it  successfully. 


26  MERCANTILE  CREDITS 


MICHAEL  CUDAHY,  President  EDWARD  A.  CUDAHY,  Vice-Prest.  4  Genl.  Manager 

CHICAGO,  ILL.  SOUTH  OMAHA,  NKB. 


PACK//V 


LOS  ANGELES,  CAL. 
Credit  department 

Los  Angeles,  Cal., I9I4- 


Dear  Sir: 


Will  you    kindly  give    us  your  opinion    of  the 
financial  standing  and  general  reputation  for   prompt- 
ness, responsibility  and  integrity  of  the  under  name  d  ? 
Your  reply  will  be  held  confidential  and  we  will  gladly 
reciprocate  at  any  time. 

Yours  truly, 

The  Cudahy  Packing  Co. 


M_ 


What  do  you  consider  his  net  worth  ? 


Credit  Information  Letter 


CREDIT  DEPARTMENT  METHODS  27 

Financial  Statements 

There  are  various  forms  used  for  financial  statements 
by  different  houses.  Good  statement  forms  used  by  prom- 
inent concerns  are  as  follows : 


1 

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ortgages,  as  follows 

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idorser  on  Notes 
jretv  on  Bonds 

I 

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as  Follows. 

Real  Estate  in  C 

I  Description 

I 

1 

.as  shown  by  sa 
The  above  stateme 

Witness 

Financial  Statement 


The  National  Association  of  Credit  Men  has  a  very 
simple  and  effective  form  of  property  statement  (shown 


28  MERCANTILE  CREDITS 


PROPERTY  STATEMENT 

Made  for  the  purpose  of  obtaining  Aline  of  credit  from  Cudahy. 


Name  of  Applicant. ......  i . ..»..,.,.., „ , 

Address _•_ . 

City,....-. -. „......*.,. State. 

Details  of  Ownership. 

Individual    > r.__. 

If  Tirm,  give  names  of  Members 


If  Corporation,  give  State  under  which  formed 

Date    I...... L > 

If  more  than  one  place  of  business  give  details.  _» . 


Property  Statement  (page  i) 

in  Chapter  IV)  ;  and  in  it  are  these  statements  which  are 
so  true  and  so  much  to  the  point  that  they  may  well  be 
quoted  here:  "Large  assets  are  not  always  necessary  to 
the  creation  of  credit.  A  merchant's  capital  is  the  sum  of 
his  net  available  resources  plus  his  credit.  A  merchant 


CREDIT  DEPARTMENT  METHODS 


29 


FINANCIAL  STATEMENT 

A*  per  Books  of  Account  as  of  Date.. 

RESOURCES 

Merchandise  on  hand,  at  actual  cost ,. ...» 

Shop  fixtures,  furniture,  and  tools,  present  value -  — 

Notes  and  accounts,  good ,. 

Notes  and  accounts,  doubtful -.  —  ....... 

Cash  in  Store 

Cash  in  what  Bank and  amount 

No.  of  Horses No.  of  Wagons Fair  value  ofBoth 

No.  of  Automobiles _ Fair  value 

All  other  personal  property  other  than  household  goods,  and  what  it  consists  - 
of 

and  fair  value - 

Real  Estate  (give  details  in  Schedule  "A"  (see  page  4) 

*Ia  any  part  of  same  a  homestead? If  so,  what  is  value  . 

•Amount  of  Life  Insurance To  whom  payable 

*Do  not  include  two  above  items  in  total. 
TOTAL- . 


Property  Statement  (page  2) 

who  desires  to  serve  his  own  best  interest  should  recognize 
that  his  most  valuable  possession,  apart  from  his  actual 
assets,  is  a  sound,  substantial,  and  unquestioned  reputa- 
tion as  a  credit  risk,  and  that  under  the  prevailing  condi- 
tions and  demands  of  business,  the  most  effective  and 


MERCANTILE  CREDITS 


LIABILITIES 


Give  names  of  parties  to  whom  owing  for  merchandise,  and  amounts 

Are  any  of  the  above  accounts  past  due?  .  .  .  i .  i..»...  Name  them 

Have  you  any  suits  pending  against  you? Amount? 

Do  you  owe  any  judgments?. Amount? 

Do  you  owe  for  tools  and  fixtures? _ Amount? 

Do  you  owe  anything  for  wages  past  due? Amount? 

Do  you  owe  any  rent  on  business  premises?. Amount?  _ 

Do  you  owe  anything  to  relatives,  and-to  whom? 

When  payable How  secured 

Other  borrowed  money?  From? Amount? 

When  due? How  payable How  secured  .. 

Any  Bank  overdrafts? ...Amount? 

Judgment  notes? ..If  so,  state  amounts  and  to  whom  given. --r.- 

Amount  liability  as  endorser  on  Notes -or  Surety  on  Bonds? 

All  other  liabilities 

TOTAL 

Net  Resources  (deduct  total  liabilities  from  total  resources) 


Property  Statement  (page  3) 

eminently  the  best  way  to  prove  his  basis  for  credit  is  to 
be  willing  to  submit  a  statement  of  his  financial  condition.*1 

Value  of  Bank  References 

Personally,  I  do  not  place  much  confidence  in  a  bank 
reference,  as  human  nature  is  the  same  everywhere.     If 


CREDIT  DEPARTMENT  METHODS  31 


Real  Estate  Owned,  Schedule  "A" 

Lot Title in Value .,.„.. Insured  for 

Lot. .' ..title  in... ,.v Value.,,.. 1 Insured  for 

Lot... Title  in ..Value..'. Insured  for. 

Lot -Title  in Value Insured  for. 

Any  Real  Estate  Mortgages? Amount? .... 


ON   WHAT   PROPERTY 


AMOUNT 


Schedule  "B" 

Any  chattel  mortgages  on  your  stock,  fixtures,  horses  and  wagons  or  other  property?. 


ON   WHAT 


TO.  WHOM  OIVEM  AMOUNT 


Rent  of  store  per  month's Other  business  expense  per  month.. 

Insurance  on  stock  and  fixtures  $..< ,.. ..Insurance  on  building?. 

Name  Fire  Insurance  Companies .» ,.. 


Does  homestead  include  store  building? When  did  you  commence  business?. 


Gkrttfirate 

...191. 


Gentlemen:— For  the  purpose  of  obtaining  credit  with  your  Company  for  Merchandise 
which  applicant  may  now  or  hereafter  obtain  and  purchase  of  you  I  hereby  certify  that  appli- 
cant keeps  books  of  account  of  all  transactions  of  the  business  and  that  the  foregoing  statements 
are  true  and'  represent  the  financial,  condition  of  applicant  as  shown  by  said  books,  and  that 
the  other  statements  above  contained  are  true  and  correct,  and  that  I  am  duly  authorised  to 
make  this  statement  on  behalf  of  applicant. 

Dated  this... v day  of-. , ...... .191 

-at fr. in  the  State  of *-. 

Authorized  signature  firm  or  corporation ... 

Signed  by  (member  of  firm  or  authorized  Officer)..- ^ -•- 

Witness: 


Property  Statement  (page  4) 

the  merchant  happens  to  be  a  customer  of  the  bank,  the 
latter  will  naturally  recommend  him  for  credit;  whereas 
some  other  bank  in  the  same  town  might  either  give  an 
unfavorable  report,  or  so  word  its  reply  that  you  could 


32  MERCANTILE  CREDITS 

infer  anything  you  wished.    In  the  reference  of  the  whole- 
saler or  jobber,  however,  I  place  every  confidence. 

Personal  Judgment  as  to  Credit  Standing 

We  will  now  take  a  case  where  James  Brown  calls  at 
your  place  of  business  to  place  an  order.  He  is  introduced 
to  the  credit  man,  who,  in  the  course  of  conversation, 
ascertains  that  the  business  is  a  small  one  and  that  the 
amount  of  credit  desired  is  light.  The  formality  of  a 
written  statement  is  therefore  not  required,  but  the  figures 
given  by  Mr.  Brown  as  to  his  assets  and  liabilities,  and  the 
names  of  the  houses  with  which  he  does  business,  are  all 
jotted  down,  and  form  part  of  the  record  which  is  kept 
of  all  customers,  further  details  of  which  are  given  later. 
In  case  Mr.  Brown  is  likely  to  desire  considerable  credit, 
a  financial  statement  is  required,  which,  when  verified  or 
corrected,  can  be  filed  with  the  other  credit  records. 

Occasionally  unfavorable  information  reaches  you  in 
reference  to  one  of  your  established  customers,  and  every 
effort  must  then  be  made  to  ascertain  the  facts.  If  the 
party  is  in  the  city,  someone  is  sent  to  make  a  personal 
call  and  get  at  the  truth;  incidentally,  of  course,  collecting 
all  the  money  he  can.  In  the  meantime  you  have  made 
a  credit  call  through  the  local  wholesalers  board  of  trade, 
or  some  other  similar  association,  the  purpose  of  which 
is  to  secure  information  as  to  the  total  amount  owing  by 
the  merchant  to  its  members,  the  total  of  what  is  past  due, 
and  also  the  manner  in  which  the  party  makes  his  pay- 
ments. On  receipt  of  this  you  may  find  that  your  custom- 
er's indebtedness  is  heavy,  and  the  amount  past  due  suffi- 
ciently large  to  embarrass  him.  Your  next  move  is  to  col- 
lect what  is  owing  to  your  firm,  or,  failing  in  this,  to 
persuade  him  to  call  a  meeting  of  his  creditors,  at  which 


CREDIT  DEPARTMENT  METHODS  33 

his  affairs  can  be  discussed  and  an  extension  agreed  upon 
by  all  the  creditors,  or  an  assignment  made  for  their 
benefit. 

The  Personal  Touch 

Make  it  a  point  to  see  the  man  to  whom  you  are  ex- 
tending credit,  if  possible,  and  preferably  at  his  place  of 
business.  Get  in  close  touch  with  your  customers  at  least 
once  a  year.  Many  is  the  time  that  I  have  met  an  insol- 
vent customer  for  the  first  time  at  a  creditors'  meeting, 
and  often  have  I  felt  that  had  I  only  seen  him  before,  I 
should  not  have  been  present  at  that  meeting. 

A  good  credit  man  should  always  be  a  good  mixer, 
and  should  have  a  good  understanding  of  human  nature. 
I  had  an  instructive  experience  only  a  short  time  ago.  One 
of  our  country  customers  had  been  a  little  slow  in  his  pay- 
merits,  and  very  touchy  when  written  to  on  the  subject  of 
his  delinquency.  I  had  an  opportunity  to  visit  him  at  his 
place  of  business,  and  was  in  his  store  fully  twenty  minutes 
before  I  was  given  any  attention.  In  the  meantime  I  noted 
the  condition  of  his  stock,  the  appearance  of  his  help  and 
of  the  store  in  general,  and  decided  that  if  I  could  collect 
our  account,  there  would  be  no  more  credit  for  him.  On 
introducing  myself  the  first  thing  I  heard  was  a  tirade 
against  the  house,  the  goods,  and  finally  myself.  I  took 
it  all  good-naturedly,  and  when  he  said,  "I'll  give  you  a 
check  for  my  account  and  never  buy  from  your  house 
again,"  I  accepted  his  check,  told  him  he  would  probably 
think  better  of  it,  but  registered  a  vow  that  he  would  never 
buy  again  on  credit  Six  weeks  later  there  was  a  call  from 
the  local  board  of  trade,  and  his  affairs  were  put  in  their 
hands.  Needless  to  say,  I  was  not  a  creditor. 


34  MERCANTILE  CREDITS 

Trade  Reports 

When  the  credit  man  receives  trade  reports,  he  ex- 
amines them  carefully,  and  notes  such  as  are  of  special 
interest  to  him.  His  assistant  cuts  out  all  items  pertaining 
to  the  customers  of  his  house,  pasting  them  neatly  in  their 
respective  folders. 

Watching  Details 

One  of  the  failings  of  the  embryo  credit  man  is  in 
trusting  too  much  to  memory;  another  the  failure  to  note 
details,  such  as  the  size  of  an  order.  I  have  a  distinct 
recollection  of  one  such  error  where  a  credit  assistant 
mistook  an  order  for  a  car  of  eggs  for  a  case  of  eggs  and 
OK'd  it.  In  the  shipping  department  no  such  error  was 
made,  the  order  being  rightly  understood  as  calling  for  a 
car  of  eggs.  The  car  was  shipped,  and  sold  by  the  cus- 
tomer, who  left  the  country  within  twenty-four  hours 
after,  and  the  house  sustained  a  loss  of  several  hundred 
dollars.  We  are  all  liable  to  such  errors,  and  the  only 
way  to  guard  against  them  is  to  surround  yourself  with 
all  the  safeguards  available. 

Recording  Information 

Collecting  data  with  regard  to  his  customers,  and 
keeping  it  in  such  a  form  as  to  be  readily  "get-at-able,"  are 
exceedingly  important  features  of  the  credit  man's  work. 
The  method  adopted  by  myself  is  to  have  a  numbered 
folder  in  which  all  information  regarding  the  customer  is 
kept,  including  the  salesman's  report,  mercantile  agency 
reports,  reports  of  references,  credit  calls,  information 
obtained  from  court  records  as  to  transfers  of  realty, 
mortgages,  etc. ;  copies  of  all  letters  written  requesting 
payments,  with  replies,  if  any,  also  memoranda  of  all 


CREDIT  DEPARTMENT  METHODS 


35 


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Information  Potter 


36  MERCANTILE  CREDITS 

postdated  checks  received  or  checks  thrown  out  of  the 
bank  on  account  of  insufficient  funds;  in  fact,  anything 
and  everything  pertaining  to  his  credit.  The  number 
appearing  on  the  folder  also  appears  on  a  card — as  shown 
below — which  bears  the  customer's  name  and  address, 
terms,  limit  of  credit  allotted  him,  together  with  mercan- 
tile agency  ratings  and  dates  of  same,  etc. 


Wft     3526                     NAMP     John  Jones, 

ABORTS      231  E.lst   St.fCity. 

v,«,r  $100.00  m  WOM«    30  Da.               .^T   Provisions 

"The  Star  Grocery" 

DATE 

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Banks:  let  National  Bank 

t/V 

X-E 

Credit  Information  Card 


Watching  the  Accounts 

Keeping  in  touch  with  the  condition  of  his  customer's 
account  is  another  important  detail  of  the  credit  man's 
work.  Various  methods  are  adopted  by  different  houses. 
The  one  I  have  found  most  effective  is  to  have  on  my  desk 
a  list  of  all  live  customers'  accounts,  that  is,  of  all  those 
who  owe  the  house  anything.  This  list  is  arranged  first 
by  territories,  either  salesmen's  or  collectors'  territories. 
In  the  case  of  salesmen  the  lists  are  made  out  alphabet- 


CREDIT  DEPARTMENT  METHODS 


37 


COLLECTIONS 

MADE  BY_  „  „  .-  _  191  

(i 

Share 

LIST  ALPHABETICALLY 

CREDIT 

Gold 
Dollars 
Halves 
Quarters 
Dimes 
Nickels 
Pennies 
Currency 
Cheques 

Total 

Remarks: 

Collector's  Report 


38  MERCANTILE  CREDITS 

ically  as  to  towns,  and  likewise  as  to  customers'  names  in 
those  towns. 

In  the  cities,  collectors  are  employed,  and  each  has  a 
territory,  which  is  divided  into  five  parts — one  for  each 
day  from  Monday  to  Friday.  Every  day  the  collector 
turns  in  the  list  of  all  the  customers  he  has  called  on,  with 
notations  against  the  names  of  any  who  have  not  paid, 
giving  the  reason  as  stated  by  the  delinquent  customer. 
Saturday  is  given  over  to  a  general  round-up  of  those  who 
were  absent  when  called  on  during  the  week.  A  glance 
over  the  list  of  customers  for  which  one  of  these  collectors 
is  responsible  will  give  you  a  fairly  accurate  idea  of  how 
closely  he  is  following  up  the  accounts.  (See  page  37.) 

The  Ledger  Account  as  a   Credit  Index 

As  a  further  help  in  passing  on  orders,  the  heading  of 
each  ledger  account  should  show  the  mercantile  agency 
ratings  and  dates  of  same,  with  the  terms  and  limit  al- 
lotted by  the  credit  department;  and  the  bookkeepers 
should  be  instructed  to  notify  the  credit  department  if  any 
customer  is  exceeding  his  limit.  Constant  reference  to 
customers'  accounts  is  absolutely  necessary  if  the  credit 
man  wishes  to  be  a  success;  and  he  should  be  in  a  position 
at  any  time  to  tell  approximately  what  a  customer  is  owing 
(especially  those  who  are  not  rated  as  absolutely  good  for 
all  they  may  order) ,  even  without  consulting  the  ledger 
account.  (For  bookkeeper's  report  see  page  39.) 

Importance  of  Prompt  Collections 

Time  is  a  great  factor  in  credit,  and  the  merchant  of 
today  has  to  work  on  a  smaller  margin  of  profit  than  he 
did  years  ago.  He  must  therefore  turn  over  his  capital 
oftener,  and  to  do  so  must  curtail  his  time  limit  to  his  cus- 
tomers whenever  this  is  possible. 


CREDIT  DEPARTMENT  METHODS  39 


Date 


Limit Time- 
Credit  Department: 

Your  attention  is  called  to  our  account  with 


Name- 


Axldress- 


No  terms  or  limit. 

Has  passed  limit. 

Is  60  days  old. 

Is  growing  quite  large. 

Is  out  of  line  and  needs  attention. 

Charges  also  coming  through  as 


-Bookkeeper. 


Bookkeeper's  Report 

The  account  of  a  slow  customer  is  a  bad  asset,  and 
such  a  customer  also  makes  unfair  competition  for  a  good 
customer  in  the  same  locality.  The  man  who  pays 
promptly  operates  on  his  own  capital;  the  man  who  is 
slow-pay  and  takes  sixty  to  ninety  days  when  he  should 
only  take  thirty  days,  is  operating  on  the  jobber's  capital. 
No  credit  man  can  claim  the  highest  degree  of  efficiency 
until  he  collects  his  accounts  as  soon  as  they  are  due. 

Routine   of   Collection  Statements 

Every  effort  should  be  made  by  the  credit  man  to  get 
his  statements  out  promptly,  for,  with  the  smaller  cus- 


MERCANTILE  CREDITS 


0) 

O 

i 
$ 

LL 
O 

I- 
LJ 


'J 


H 


Collection  List 


CREDIT  DEPARTMENT  METHODS  41 

tomer  especially,  it  is  a  case  of  first  come,  first  served, 
and  payments  are  made  accordingly.  It  is  claimed  by 
some  that  the  weekly  rendering  of  statements  involves  too 
much  work,  but  in  this  I  cannot  agree. 

In  order  to  have  the  collection  system  work  satisfac- 
torily, it  is  sometimes  arranged  that  the  bookkeepers  shall 
make  out  statements  on  a  systematic  schedule — on 
Wednesday  of  each  week,  all  ten-day,  fifteen-day,  thirty- 
day,  and  sixty-day  accounts  are  turned  over  by  the  book- 
keeping department  to  the  credit  department;  on  Friday 
and  Saturday,  all  weekly  accounts,  and  on  the  first  of  the 
month,  all  monthly  accounts.  These  are  sorted  and  listed. 
The  form  we  use  for  this  "Collection  List,"  as  it  is  called, 
is  shown  on  page  40. 

All  statements  and  all  collection  lists  are  made  in 
duplicate,  the  original  statement  going  to  the  customer, 
while  the  duplicate  statement  and  original  list  go  to  the 
salesman  or  collector,  and  the  duplicate  list  is  kept  in  the 
credit  department. 

This  list  keeps  the  salesman  informed  as  to  which  of 
his  customers  are  owing  past-due  bills,  which  he  is  ex- 
pected to  collect.  Where  customers  are  more  than  usually 
delinquent,  letters  are  written  to  the  salesman,  calling 
special  attention  to  the  delinquency.  At  the  end  of  each 
week  the  salesman  attaches  to  his  expense  account  the  list 
furnished  to  him,  on  which  he  has  noted  the  result  of  his 
efforts.  (See  page  42.)  These  are  carefully  recorded,  and, 
if  promises  to  pay  on  certain  dates  are  shown,  the  sales- 
man is  reminded  of  these  dates  on  his  next  list,  or,  in 
certain  instances,  a  letter  is  written  direct  to  the  customer. 

Routine   of   Collection — Incoming   Mail 

Many  credit  men  handle  all  the  mail  as  it  arrives ;  but 
in  large  houses  this  is  impracticable.  Our  method  is  to 


42  MERCANTILE  CREDITS 


ON  UNCOLLECTED  ITEMS: 


THE  CUDAHY  PACKING  CO. 

GENTLEMEN;  •- 

HAVE  BEEN  UNABLE  TO  MAKE  COLLECTION 

FROM 


FOR  THE  FOLLOWING  REASONS.' 


(SALESMAN) 
DATE 

Salesman's  Report 


CREDIT  DEPARTMENT  METHODS  43 

sort  city  from  country  mail  as  nearly  as  can  be  done  by  the 
postmarks.  It  is  then  opened  by  different  clerks,  who 
sort  out  orders  and  remittances  first.  The  former  go  to 
the  order  department,  and  the  remittances  to  the  credit 
department,  where  notations  are  made  of  them  on  the 
collection  lists.  All  remittances  having  deductions  of  any 
kind  are  referred  to  the  claim  clerk  for  adjustment,  the 
remainder  going  to  the  cashier  for  entry.  By  this  time  the 
orders,  properly  written  up,  begin  coming  in  from  the 
order  department,  and  the  passing  upon  and  OK'ing  for 
shipment  begins. 

In  this  way  all  remittances  are  entered  on  the  credit 
department  collection  lists,  and  the  credit  man  knows  at 
once,  without  having  to  consult  the  ledgers,  how  custom- 
ers are  paying,  who  is  discounting,  who  is  not,  who  pays 
drafts,  etc. 

Routine  of  Collection  —  Outgoing   Mail 

All  copies  of  letters  to  customers  relative  to  their 
accounts,  are  carefully  filed  to  come  up  from  three  to  five 
days  later,  allowing  sufficient  time  for  the  mails  to  bring  a 
reply.  If  no  reply  has  been  received,  notice  of  draft  is 
sent  or  draft  itself  made.  These  come  up  in  rotation,  and 
if  the  account  is  still  unpaid,  the  next  step  is  left  to  the 
judgment  of  the  credit  man — another  letter,  threat  of 
suit,  etc.,  etc. 

Arrangement  of  Ledger  Accounts 

There  are  certain  lines  of  business  where  a  card  ledger 
system  for  keeping  the  accounts  of  customers  is  undoubt- 
edly good;  but  in  a  business  having  a  large  number  of  ac- 
counts, it  is,  in  my  opinion,  impracticable,  and  the  loose- 
leaf  ledger  system  preferable. 

The  form  and  arrangement  of  ledger  sheets  are  of 


44  MERCANTILE  CREDITS 

prime  importance  to  the  credit  department  and  should  be 
given  careful  consideration. 

There  are  four  general  ways  of  arranging  the  ledger, 
one  of  which  is  in  use  by  almost  every  large  house. 

1 i )  The  straight  numerical  arrangement  requiring  an 
index,  and  lacking  efficiency  by  reason  of  the  necessity  of 
continual  reference  to  same. 

(2)  Arrangement  according  to  salesmen's  territories, 
the  sheets  in  each  territory  being  assigned  a  certain  set  of 
numbers.     While  this  arrangement  has  some  features  to 
commend  it,  it  again  involves  the  use  of  an  index. 

(3)  Territorial   arrangement,    in  which   all  the   ac- 
counts in  each  state  are  arranged  alphabetically  according 
to  the  towns  and  cities  of  the  state,  the  individual  accounts 
being  arranged  alphabetically  under  the  name  of  the  town. 
This  arrangement  necessitates  an  index,  but  it  is  rarely 
used,  as  practically  every  order  gives  the  address  necessary 
to  locate  the  account.     It  facilitates  statistical  work  re- 
garding the  volume  of  business  from  any  one  town,  and 
enables  the  credit  man  to  see  what  accounts  are  to  be  given 
preference   at   any  point;    and  it  is    therefore   strongly 
recommended. 

(4)  An  alphabetical  arrangement  according  to  cus- 
tomers' names,  which  is  recommended  by  many  credit  men 
and  is  particularly  suited  to  certain  lines.    This  would  be 
my  own  choice. 

Credit   Insurance 

There  are  companies  which  insure  jobbers  and  manu- 
facturers against  credit  losses,  but  I  am  not  altogether 
favorably  disposed  to  this  class  of  insurance.  In  the  first 
place,  the  usual  method  of  such  a  company  is  to  base  the 
initial  loss  the  manufacturer  must  stand  on  the  percentage 
of  loss  sustained  for  five  years  previous.  This  is  regarded 


CREDIT  DEPARTMENT  METHODS  45 

as  the  probable  or  certain  loss,  and  they  insure  the  losses 
above  that  amount.  This  is  scarcely  equitable,  as  in  some 
years  abnormal  losses  are  sustained,  which  would  raise  the 
"probable  loss"  to  a  point  which  may  never  be  reached 
again.  My  principal  objection,  however,  is  that  the  credit 
man,  with  a  knowledge  that  his  losses  are  insured,  is  apt 
to  allow  his  judgment  to  be  deadened,  and  "take  a  chance" 
which  he  would  otherwise  have  refused. 

Bad   Debts 

There  is  one  thing  the  credit  man  should  under  all  cir- 
cumstances endeavor  to  avoid,  and  that  is  "Bad  Debts" ; 
but  unfortunately  he  gets  them;  and  his  work  is  not  ended 
when  he  writes  off  an  account  to  his  Suspense  account. 
(The  Suspense  account  contains  a  list  of  all  bad  and 
doubtful  accounts,  and,  with  some  houses,  all  accounts  that 
may  take  an  indefinite  time  to  collect.) 

I  keep  particulars  of  all  such  accounts  in  a  separate 
folder,  containing  everything  pertaining  to  the  case  from 
the  time  the  customer  became  insolvent,  duplicates  of  the 
bills,  with  receipts  for  same  attached,  together  with  any 
information  as  to  property  the  debtor  has  or  is  supposed 
to  have.  Knowledge  of  the  debtor's  whereabouts  is  al- 
ways at  hand,  and  from  time  to  time  efforts  are  made  to 
collect.  Frequently  arrangements  can  be  made  for  the  pay- 
ment of  small  sums  weekly  or  monthly,  and  the  account 
can  be  gradually  collected  in  this  manner. 

In  addition  to  the  folder  I  keep  a  suspense  ledger  in 
which  is  entered  the  amount  of  debt  and  payments  received 
thereon.  This  ledger  should  be  kept  by  the  credit  man- 
ager himself  or  his  assistant. 

Even  in  cases  where  the  debtor  compromises  and  re- 
ceives a  release  in  full,  I  have  frequently  been  able  to 
collect  the  balance  of  my  account  when  he  resumed  busi- 


46  MERCANTILE  CREDITS 

ness  or  inherited  property.  Such  cases  are,  of  course, 
rare,  but  still  they  show  that  it  pays  to  keep  in  touch  with 
the  suspended  or  bad  debt  accounts ;  and  I  strongly  recom- 
mend all  credit  men  to  give  these  suspended  accounts  all 
the  attention  possible.  Results  will  show  the  wisdom  of 
this  course. 

Securing  Accounts 

Before  closing  I  desire  to  call  attention  to  various 
methods  of  securing  an  account: 

(1)  By   guarantee   of   some   responsible   party,    for 

which  two  suitable  forms  are  submitted. 

(2)  By  a  guarantee  which  includes  a  financial  state- 

ment of  the  guarantor,  making  the  guarantee 
that  much  more  binding  on  him. 

(3)  By  a  simple  guarantee. 

Los  Angeles,  Cal.,  

To        (Name  of  Creditor) 

For  value  received,  I  hereby  guarantee  the  prompt  payment  to 

THE  CUDAHY  PACKING  COMPANY  of  the  account  of ,  which 

is  or  may  become  due  them,  to  the  extent  of  $ ,  hereby 

waiving  notice  of  the  extension  of  credit  or  delinquency  of  payment. 

This  guaranty  to  continue  until  revoked  by  me  in  writing. 


For  the  purpose  of  making  the  above  guaranty  acceptable  to 
THE  CUDAHY  PACKING  COMPANY  and  to  obtain  credit  thereunder  for 

above  named,  I  hereby  state  that  I  am  the  sole  owner 

of  personal   property  to   the   value   of  $ —  -  and   real   estate 

property  in  the  name  of  —  ,   located  at  —    ,  in 

the  City  of  ,  County  of  ,  State  of  — , 

valued  at  $ ,  encumbered  for  $ ' ,  and  that  I  am 

worth    over   and   above    all   debts    and    exemptions    not    less    than 
$ . 


Guaranty  of  Payment  (Form  i) 


CREDIT  DEPARTMENT  METHODS 


47 


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48 


MERCANTILE  CREDITS 


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CREDIT  DEPARTMENT  METHODS  49 

The  bill  of  sale  and  the  fixture  lease  under  the  Cali- 
fornia law,  may  also  be  mentioned.  The  bill  of  sale  of  a 
stock  of  merchandise  or  fixtures  is  only  binding  when  pos- 
session is  given.  The  bulk  sales  law  provides  that  the 
sale  of  a  stock  of  goods  must  be  advertised  for  five  days. 
This  does  not  apply  to  fixtures.  The  fixture  lease  is  an 
arrangement  by  which  fixtures  remain  the  property  of  the 
lessor  until  payment  of  the  purchase  price  has  been  made. 
Usually  the  lease  provides  for  monthly  payments  until  the 
total  sum  agreed  on  has  been  paid. 


CHAPTER  III 

BANK  CREDITS 

BY  J.  M.  ELLIOTT 

Bank  Credits   Defined 

Credit  is  defined  by  the  dictionaries  as :  "The  degree 
of  confidence  in  the  ability  and  disposition  of  a  person,  a 
firm,  corporation,  or  government,  to  meet  its  financial  obli- 
gations." This  is  the  correct  definition  of  the  word  from 
the  standpoint  of  the  bank,  though  the  expression  also 
means  the  permission  given  by  a  bank  to  a  certain  individ- 
ual to  draw  upon  it  for  a  given  amount.  This  permission 
sometimes  takes  the  form  of  what  is  called  a  "Letter  of 
Credit." 

Good  judgment  in  bank  credits  is  the  ability  to  deter- 
mine whether  the  loan  requested  is  going  to  be  repaid 
with  interest.  To  the  credit  man  that  is  his  only  concern 
in  the  matter;  and  the  ability  to  find  out  that  one  thing  be- 
forehand is  the  distinguishing  characteristic  of  the  good 
credit  man. 

"Changes   and   Chances" 

There  is  an  expression  in  the  Episcopal  Prayer  Book 
which  every  man  in  the  banking  business,  as  a  lender, 
should  have  always  in  mind;  and  that  is — "the  sundry  and 
manifold  changes  and  chances  of  this  mortal  life."  A 
man  comes  and  asks  for  a  credit.  He  is  in  full  health — 
in  the  full  possession  of  all  his  faculties.  He  looks  as  if 

50 


BANK  CREDITS  51 

he  would  go  on  indefinitely;  but,  when  he  tells  his  story  of 
what  he  wants  that  money  for,  and  just  what  use  he  can 
make  of  it,  and  how  he  expects  to  return  it — there  being 
apparently  no  flaw  in  his  explanation — you  must,  as  you 
listen  and  decide,  keep  that  phrase  in  your  mind. 

Credit   Applications  —  Professional   Men 

Many  men  think  that  they  have  credit,  or  that  they 
should  be  entitled  to  it,  when  they  are  not.  I  will  take  as 
an  instance  a  professional  man.  He  makes  a  statement  to 
you  of  what  he  is  worth  and  what  he  owes.  This,  of 
course,  is  the  first  thing  to  have  before  you  in  determining 
whether  the  credit  is  a  good  one  or  not.  He  says  that  he 
has  $500  in  the  bank  that  he  can  draw  upon  at  any  time; 
that  he  has  due  to  him  for  professional  services,  say, 
$2,500;  that  he  owns  an  automobile  which  cost  $1,200; 
and  in  addition  to  all  this,  10,000  shares  in  the  Blue  Sky 
Oil  Company — which,  however,  he  has  to  acknowledge 
has  forfeited  its  lease,  making  the  shares  not  very  good  as 
collateral.  He  also  has  a  house,  a  home,  which  stands  in 
his  own  name,  and  in  which  his  family  resides,  worth 
$6,500,  and  all  the  usual  tools  of  his  trade.  If  he  is  a 
surgeon,  he  has  perhaps  instruments  worth  $500.  One 
thing  more  he  has,  and  that  is  life  insurance  upon  which 
he  is  paying  $499  a  year  in  premiums,  and  which  is  pay- 
able to  his  estate  when  he  dies.  On  the  other  hand,  he 
owes,  say,  $1,200  or  $1,500  on  different  bills,  and  he 
wishes  to  borrow  $1,000  to  pay  these  bills. 

The  first  item,  $500  cash  in  the  bank,  is  a  good  basis 
of  credit.  The  next  item,  however — the  $2,500  of  pro- 
fessional credits  due  to  him — would  shrink,  were  he  to 
die,  to  a  very  small  sum.  He  will  tell  you,  if  closely  ques- 
tioned, that  a  great  deal  of  it  is  past  due,  and  that  he  has 
absolutely  made  up  his  mind  that  he  is  going  to  lose  at 


52  MERCANTILE  CREDITS 

least  half  of  it.  As  to  his  automobile,  it  is  a  considerable 
expense,  and  bankers  frequently  think  of  an  automobile  as 
a  liability  instead  of  an  asset.  But  he  has  his  house,  worth 
$6,500,  and  his  professional  instruments  worth  $500,  and 
his  life  insurance,  which  will  go  to  his  estate  when  he  dies, 
and  which  would  pay  his  debts. 

The  first  thing  to  tell  this  man  is  that  the  law  makes 
his  home,  to  the  amount  of  $5,000,  absolutely  exempt; 
and  that  all  that  his  wife  has  to  do  when  the  sheriff  has 
his  hand  raised  to  say  "Gone"  to  a  bidder,  is  to  put  in  a 
little  paper  which  reads  "Homestead,"  and  that  sheriff's 
hand  is  suspended. 

The  law  says  also  that  the  instruments  which  he  owns 
are  instruments  of  his  trade,  and  that  they  are  not  subject 
to  execution. 

There  is,  of  course,  his  life  insurance  to  levy  on  in 
case  of  his  death.  But  the  law  steps  in  again  and  says  that 
any  life  insurance  bought  at  a  rate  under  $500  a  year  be- 
longs to  his  wife  when  he  dies,  no  matter  whether  it  is 
decreed  to  go  to  his  estate  or  not. 

Therefore,  all  that  you  have  to  depend  upon  for  the 
repayment  of  that  loan  is  the  $500  in  the  bank,  which  he 
may  spend  at  any  time,  and  whatever  could  be  recovered 
from  the  claims  he  has  against  patients  for  work  done. 
But  there  is  still  another  question  which  you  have  to  take 
into  consideration.  Suppose  that  man  is  injured  severely, 
or  that  he  has  a  grievous  illness  which  continues  for  some 
time.  He  has  to  pay  the  $500  or  the  $499  a  year  to  keep 
up  his  life  insurance.  Don't  you  see  that  he  will  sacrifice 
nearly  everything  he  owns  in  the  world  in  order  to  keep 
up  that  amount  of  life  insurance  for  his  wife  and  children, 
and  that  he  will  let  his  creditors  go  ? 

That  is  a  sample  of  what  bankers  have  to  consider 
when  they  have  a  credit  application  before  them. 


BANK  CREDITS  53 

Credit  Applications — Corporations  and  Partnerships 

When  the  application  comes  from  a  business  house,  of 
course  the  matter  is  entirely  different.  We  ask  the  same 
questions,  but  we  ask  a  great  many  more.  As  you  know, 
a  majority  of  the  business  houses  in  this  country  are  run 
as  corporations,  though  often  these  corporations  are 
owned  by  a  very  few  people.  This  is  done  on  account  of 
the  disadvantages  of  partnership ;  for  when  a  partner  dies, 
his  estate  may  have  to  pass  through  much  legal  con- 
troversy in  which  the  partnership  is  more  or  less  involved, 
whereas,  if  one  of  the  holders  of  the  stock  of  a  corpora- 
tion dies,  the  stock  only  goes  into  his  estate,  and  the  cor- 
poration is  not  necessarily  interfered  with  in  any  way. 

There  is  a  difference  also  in  the  liability  for  debt. 
Each  member  of  a  partnership  is  liable  for  the  entire  debt 
of  the  firm,  while  a  stockholder  at  the  worst  is  liable  for 
the  debts  of  the  corporation  only  in  proportion  to  the 
amount  of  his  stock,  and  in  most  states  is  not  liable  at  all. 
For  this  reason,  when  a  corporation  is  in  the  least  doubt- 
ful, banks  require  that  its  paper  shall  have  the  indorse- 
ment of  the  persons  most  strongly  interested  in  it.  When 
this  is  refused  it  is  an  evidence  that  these  gentlemen  are  a 
little  afraid  of  the  corporation;  and  the  bank  is  fully  justi- 
fied in  saying  "No"  to  the  application  for  credit. 

Sometimes  there  are  four  or  five  of  the  members  of 
the  board  of  directors  who  are  willing  to  indorse,  but  the 
other  man,  being  exceedingly  careful,  or  perhaps  a  little 
crabbed,  says  he  will  not.  A  bank  must  then  use  its  judg- 
ment as  to  whether  it  will  take  the  names  of  the  four. 

Sometimes  there  is  one  man  among  the  directors  who 
is  known  to  be  absolutely  good  for  any  contract  that  he 
may  make;  and  the  bank  says  to  him,  "If  you  are  willing 
to  indorse  this  paper,  we  will  take  it."  Sometimes  he  will, 
and  if  he  does  the  bank  has  good  security. 


54  MERCANTILE  CREDITS 

Form  of  Indorsement 

I  may  mention  here  one  rather  important  little  techni- 
cality. A  man  who  indorses  his  name  upon  a  note  is  liable 
upon  it  until  that  note  is  due ;  but  then,  if  the  note  is  not 
protested — that  is,  if  an  official  notice  is  not  sent  to  him 
that  the  money  has  been  demanded  from  the  maker  and 
the  maker  has  refused  to  pay  it — his  liability  is  question- 
able, and  may  be  worthless.  In  order  to  be  sure  that  this 
does  not  occur,  careful  banks  have  the  indorsement  made 
upon  the  back  of  that  paper  twice;  near  the  top  where 
there  is  nothing  above  it,  and  in  the  center  of  the  note, 
under  the  stamp  which  says :  "For  value  received  we 
jointly  and  severally  hereby  guarantee  the  payment  of  the 
within  note,  hereby  waiving  presentment,  demand,  and 
notice  of  non-payment  and  protest."  When  this  is  done 
the  indorsement  is  a  guarantee  of  that  note  as  long  as  it 
lives,  that  is,  up  to  four  years. 

I  have  seen  a  case  illustrating  this  point.  One  in- 
dorser,  after  the  five  names  had  been  signed,  wrote  in 
above  them  a  guarantee  similar  to  the  form  quoted  in  the 
preceding  paragraph,  then  took  the  note  to  the  bank, 
where  it  was  accepted.  The  other  four  directors  after- 
wards claimed  that  when  they  signed  their  names  the 
guarantee  was  not  on  the  note,  and  that  they  were  entitled 
to  have  notice  of  protest  of  the  note  when  due,  that  having 
no  such  notice  they  had  reason  to  believe  the  note  paid, 
and  that  therefore  their  liability  had  ceased.  The  law 
upheld  this  contention  as  to  the  four,  and  laid  the  burden 
on  the  one  man  who  had  made  the  false  record. 

Indorsement  of  the  Board  of  Directors 

In  California  a  loan  made  to  a  corporation  without  a 
resolution  of  the  board  of  directors  authorizing  the  presi- 
dent and  secretary,  or  some  of  the  officers,  to  sign  the  note, 


BANK  CREDITS  55 

is  only  good  against  that  corporation  if  the  bank  can  prove 
that  the  corporation  itself  obtained  the  benefit.  Even  in 
this  case  there  can  be  no  interest  collected.  Most  banks, 
therefore,  provide  a  form  to  be  filled  out  by  the  officers 
of  corporations  asking  for  loans ;  and  this  form  calls  for 
the  formal  sanction  of  the  board  of  directors. 

But  there  are  times  when  a  corporation,  for  some  rea- 
son, cannot  have  a  meeting  of  its  board  of  directors ;  and 
in  such  cases  it  has  been  my  custom  to  change  the  form  of 
guarantee  thus:  "We,  the  undersigned,  jointly  and  sev- 
erally guarantee  the  validity  as  well  as  the  payment  of  the 
within  note."  I  have  never  known  that  form  of  guaranty 
to  be  broken,  and,  consequently,  I  think  it  is  good,  for  it 
holds  the  officers  personally  responsible  for  the  perform- 
ance of  the  act  by  the  corporation.  The  California  law 
requiring  the  resolution  of  the  board  is  only  a  remi- 
niscence, a  reminder  of  early  times,  fifty  years  ago,  when 
mining  corporations  could  borrow  anything  that  they  felt 
like  and  give  the  notes  of  the  corporation  for  it.  The 
law  was  passed  to  prevent  this;  but  in  other  states,  cor- 
porations give  notes  bearing  merely  the  signatures  of  their 
officers,  which  are  good  against  the  corporation. 

Corporation  Statements 

We  will  suppose,  however,  that  the  corporation  ap- 
plies for  a  loan  in  proper  form,  and  is  asked  to  make  its 
statement  to  its  bank.  It  says  it  has  $5,000  in  bank;  it  has 
$100,000  worth  of  merchandise,  reckoned  at  cost  price 
without  adding  any  profit.  It  has  $100,000  of  good  ac- 
counts on  its  books  for  goods  sold  and  delivered  not  more 
than  60  or  90  days  previous,  the  bills  for  which  are  not  yet 
due.  It  has,  say,  $5,000  of  older  accounts  which  have 
now  passed  into  the  category  of  doubtful  paper.  It  owns 
real  estate  worth  $25,000. 


56  MERCANTILE  CREDITS 

On  the  other  hand,  it  has  a  debit  of  $50,000  to  its 
bank,  and  $50,000  to  persons  and  firms  for  merchan- 
dise. 

Quick  Assets  Must  Exceed  Liabilities 

In  passing  on  such  an  application,  the  first  step  is  to 
compare  the  quick  assets  of  the  firm  with  the  quick  liabili- 
ties— that  is  to  say,  the  debts  due  with  the  money  avail- 
able. All  liabilities,  with  the  exception  of  bonds  and 
mortgages,  may  thus  be  termed  "quick";  but  quick  assets 
include  only  cash,  and  property  which  can  promptly  be 
exchanged  for  it.  Solvency  depends  upon  a  supply  of  such 
available  assets  sufficient  to  meet  the  demand. 

For  instance,  accounts  receivable  for  goods  sold  to 
reliable  firms  would  ordinarily  be  considered  quick  assets. 
But  these  should  always  be  much  in  excess  of  the  quick 
liabilities,  for  in  times  of  panic  they  cannot  be  realized  on 
with  certainty.  Still,  the  good  customers  will  force  their 
goods  out  and  meet  their  liabilities.  Bankers  will  remem- 
ber that  in  1907  a  great  many  persons  sold  their  goods 
without  profit  in  order  to  come  to  the  assistance  of  the 
banks  which  had  favored  them  in  the  past,  paying  off  a 
considerable  proportion  of  their  indebtedness,  whether 
or  not  it  was  due.  Here  again  we  see  the  importance  of 
the  personal  element  in  credit  granting. 

Real  estate  and  buildings  can  never  be  considered 
quick  assets.  The  capital  stock  of  a  corporation,  on  the 
other  hand,  is  not  a  quick  liability,  because  the  persons  sub- 
scribing for  the  stock  cannot  withdraw  their  money,  at 
least  until  the  company  is  liquidated  and  all  the  debts  are 
paid.  Furniture  and  fixtures  are  slow  assets;  and  the 
machinery  in  a  manufacturing  establishment  is  an  asset  so 
very  unavailable  that  10  to  25  per  cent  per  annum  should 
be  allowed  on  the  books  for  depreciation,  if  its  value  is  to 
be  fairly  stated. 


BANK  CREDITS  57 

A  Good  Statement 

Now,  in  the  case  under  consideration,  the  corporation 
has  $5,000  in  the  bank,  which  is  an  absolutely  quick  asset. 
It  has  $100,000  due  from  merchants  who  have  purchased 
goods  from  it,  and  its  treasurer  can  confidently  judge  by 
his  past  experience  what  proportion  of  this  will  be  paid 
within  60  days — say  95  per  cent.  In  60  days,  therefore, 
the  representative  of  the  corporation,  with  his  $5,000  in 
the  bank  and  the  $95,000  that  he  may  reasonably  expect 
to  receive,  will  be  able  to  pay  every  dollar  that  he  owes. 
Such  a  man  can  come  to  the  bank  with  his  statement,  and 
can  confidently  expect,  if  he  has  treated  the  bank  with 
proper  liberality,  that  he  will  get  $50,000  on  the  strength 
of  the  name  and  reputation  of  his  firm,  or  of  the  corpora- 
tion which  he  represents. 

In  making  a  decision  as  to  what  an  applicant's  credit 
is  worth,  it  is,  of  course,  necessary  to  take  up  the  quick 
assets  first.  If  there  are  a  number  of  fixed  assets  back  of 
these,  it  naturally  increases  the  value  of  the  loan  and 
makes  it  still  more  secure. 

A  Doubtful  Statement 

But  all  corporations  are  not  like  the  one  just  described. 
Suppose  a  corporation  has  $5,000  in  bank,  and  $100,000 
of  credits,  $50,000  of  which  have  come  in  within  the  last 
60  days,  while  the  other  $50,000  have  been  on  the  books 
from  90  days  to  a  year  or  two.  When  the  merchandise 
represented  by  the  $100,000  on  the  applicant's  statement 
is  examined  by  the  bank  (which  in  this  instance  is  careful 
to  find  out  the  value  of  the  merchandise  on  hand)  a  large 
part  of  it  is  found  to  be  old  stock,  the  whole  being  put  in 
at  a  price  in  excess  of  its  cost.  Nevertheless,  this  mer- 
chant thinks  himself  strong. 


58  MERCANTILE  CREDITS 

The  bank  loans  him  $20,000  or  $25,000,  with  con- 
siderable doubt,  and  if  that  $25,000  is  not  paid,  it  looks 
into  the  condition  of  the  report  sent  in  about  every  six 
months.  If  the  corporation  is  not  showing  a  steady  de- 
crease in  the  bad  paper  on  its  books,  and  an  equally  steady 
increase  in  the  good  paper — if  the  merchandise  on  its 
books  is  not  put  in  at  its  real  value,  and  the  worthless,  or 
nearly  worthless,  stuff  disposed  of — that  $25,000  will  be 
called  by  the  bank. 

Credit  Applications — The  Retail  Man 

Now,  if  the  applicant  for  credit,  instead  of  being  a 
corporation,  is  the  owner  of  a  retail  store — a  drug  store  or 
a  grocery — the  application  must  still  be  handled  on  the 
same  basis.  But  we  must  lay  even  more  emphasis  upon 
the  personal  equation — that  is,  we  must  ask  if  the  man 
running  the  store  is  likely  to  make  a  success.  This  per- 
sonal factor  is  one  of  the  things  that  a  bank  must  always 
consider.  If  it  lends  to  a  man  who  is  unsuccessful,  and 
who  has  virtually  proven  himself  to  be  unsuccessful,  it  is 
taking  a  very  much  greater  risk  than  it  is  with  a  man  who 
has  no  better  material  basis  for  credit,  but  who  has  an- 
other great  basis  for  credit  within  himself — the  ability  to 
succeed.  The  Spaniards  have  a  proverb  which  says: 
"When  an  unlucky  man  becomes  a  hat  maker,  his  children 
are  born  without  heads."  There  are  some  people  who 
are  very  unfortunate  by  nature,  and  it  has  hurt  my  heart 
many  and  many  a  time  when  I  have  told  them  that  not- 
withstanding the  statement  they  made,  the  bank  could  not 
and  would  not  advance  them  anything  whatever.  Such  a 
person  is  impossible  to  describe,  but,  somehow,  that  man 
will  make  some  admission  in  talking  to  you  which  will 
give  you  a  clue;  and  after  a  further  examination  of  his 
characteristics,  and  of  his  lack  of  success  in  the  past,  you 


BANK  CREDITS  59 

will  see  that  he  is  a  man  whom  it  is  absolutely  impossible 
to  help.  In  such  a  case  it  would  not  even  be  real  humanity, 
much  less  good  business,  to  make  a  loan. 

The  Personal  Element 

Banks  take  the  statements  of  their  customers  year  by 
year,  or  period  by  period,  and  analyze  them.  Parallel 
columns  show  what  the  condition  was  in  1909,  in  1911,  in 
1912,  and  in  1913,  and  the  evidence  of  prosperity  thus  ob- 
tained means  that  the  firm's  credit  is  increasing,  whereas, 
if  the  account  is  unfavorable  and  shows  that  it  is  not  mak- 
ing its  way,  that  credit  has  to  be  cut  off. 

Bank  men,  however,  cannot  be  altogether  cold- 
blooded. It  would  not  be  wrong  to  say  that  they  must  ex- 
ercise a  great  deal  of  human  kindness,  and  a  great  deal  of 
human  discernment.  The  banker  who  is  absolutely  cold- 
blooded and  hard  in  all  of  his  dealings  is  not  a  success. 
In  considering  any  application  for  money  every  circum- 
stance connected  with  it  must  be  carefully  weighed.  Some- 
times one  man  can  get  credit  when  he  is  seemingly  less 
worthy  of  it  than  another  man,  because  of  circumstances 
connected  with  the  application  which  make  it  wise  for  the 
bank  to  take  a  little  risk.  Again,  a  man  keeps  an  account 
with  a  bank  for  years,  and  is  straightforward  and  friendly 
in  his  dealings  with  it.  Owing  to  a  change  in  his  affairs, 
perhaps  due  to  his  having  signed  notes  for  other  people, 
perhaps  to  trouble  in  his  family,  or  to  some  other  accident, 
that  man  has  to  come  and  ask  for  a  larger  credit  than  he 
is  entitled  to.  If  he  is  honest,  he  should  have  it.  The 
bank  that  makes  such  little  differences,  and  recognizes  the 
personal  element,  is  the  one  that  succeeds. 

The  officers  of  such  an  institution  should  also  be  quick 
to  recognize  ability  and  foresight,  and  economy  in  per- 
sonal affairs,  on  the  part  of  young  men  just  starting  out, 


60  MERCANTILE  CREDITS 

and  should  help  such  men,  conservatively,  of  course,  never 
advancing  any  large  amount.  By  making  themselves,  as  it 
were,  advisers  and  elder  partners  for  a  time,  they  help  to 
make  these  men  and  to  build  up  the  great  institutions  of  a 
city,  and  in  doing  this  they  gain  the  eternal  friendship  of 
those  whom  they  have  befriended. 

But  though  all  this  is  true,  sympathy  must  not  be  al- 
lowed to  overrule  judgment.  The  bank  officer  who  for- 
gets this  is  not  a  safe  man  to  be  intrusted  with  other 
people's  money.  He  has  to  walk  along  a  very  narrow 
path  with  dangers  on  both  sides ;  and  if  any  man  has  ever 
found  out  the  way  of  absolutely  marking  down  that  path 
with  a  line,  I  have  never  seen  him,  nor  have  I  had  the 
pleasure  of  reading  what  he  has  done. 

Collateral 

But  sometimes  men  who  are  customers  of  banks  come 
in  and  say,  "I  am  in  want  of  a  loan,  I  am  one  of  your  cus- 
tomers, and  I  have  this  collateral."  You  do  not  have  to 
ask  such  a  man  for  a  statement.  He  says,  "I  don't  care  to 
give  you  a  statement  of  my  affairs.  You  can  see  from 
your  books  what  kind  of  an  account  I  have  kept  with  you. 
I  have  kept  an  average  balance  of  $1,500  or  $2,000. 
Now  I  want  $20,000  for  a  short  time,  and  I  want  you  to 
carry  $10,000  for  three  months,  and  $10,000  for  six 
months,  and  I  should  be  glad  to  have  you  look  at  this  col- 
lateral." Then  the  bank  officer  must  exercise  his  discern- 
ment as  to  the  value  of  the  collateral.  Business  men  do 
not  have  the  best  collateral,  such  as  government  bonds, 
state  and  county  bonds,  municipal  bonds.  On  such  bonds 
banks  will,  of  course,  make  a  loan  of  95  per  cent  at  any 
time  and  be  sure  that  they  are  all  right;  but  more  fre- 
quently the  borrower  comes  in  with  some  Union  Oil  Stock, 
or  some  Edison  Preferred,  and  a  number  of  other  stocks 


BANK  CREDITS  61 

which  must  be  criticized  and  scrutinized.  The  banker 
must  know  something  about  the  management  of  the  cor- 
porations represented  by  this  stock,  and  the  conditions 
upon  which  the  stock  or  bonds  are  issued;  whether  the 
real  estate  that  the  corporation  owns  is  clear;  whether  it 
has  paid  dividends  for  a  number  of  years  and  seems  likely 
to  do  so.  If  all  these  questions  can  be  answered  satisfac- 
torily, that  stock  is  good,  provided  it  does  not  belong  to  a 
private,  or  what  is  called  a  "close,"  corporation. 

Stock  brought  in  as  collateral  may  seem  to  be  perfectly 
good,  but  just  as  careful  an  analysis  should  be  made  of  the 
affairs  of  the  company  which  issues  that  stock  as  is  made 
of  the  affairs  of  any  corporation  which  is  borrowing  di- 
rectly from  the  bank.  It  should  be  ascertained,  first,  if  the 
real  estate  which  represents  a  certain  proportion  of  the 
assets  is  mortgaged.  If  it  is  mortgaged,  you  are  merely 
taking  a  part  of  a  second  mortgage  as  collateral,  and  the 
man  who  takes  a  second  mortgage  must  always  be  pre- 
pared to  have  the  holder  of  the  first  mortgage  come  and 
say,  "Will  you  pay  me,  or  will  you  lose  your  second  mort- 
gage?" A  bank  which  takes  collateral  of  that  kind  must 
always  remember  that  it  is  running  this  risk,  and  that,  as 
a  general  thing,  it  is  entirely  unsafe  to  do  so. 

The  Close  Corporation 

A  close  corporation  is  one  in  which  the  stock  is  owned 
by  a  very  few  people.  It  is  generally  a  business  firm  which 
has,  for  reasons  of  convenience,  incorporated;  and  some- 
times there  is  one  man  who  owns  nearly  all  the  stock,  but 
has  put  one  share  each  into  the  names  of  two  or  four  mem- 
bers of  his  family  who  act  as  directors.  That  is  the  closest 
kind  of  a  corporation;  but  the  California  law  allows  a  cor- 
poration to  be  created  with  only  three  directors,  and  thus 
makes  it  possible  for  two  members  of  a  firm  to  form  a 


62  MERCANTILE  CREDITS 

corporation,  and  divide  the  stock  between  them  (with  the 
exception  of  two  or  three  shares  allotted  to  some  member 
of  their  own  family,  or  perhaps  to  some  trusted  employee, 
in  order  to  have  the  necessary  number  of  directors),  and 
such  a  corporation  is  almost  as  close  a  corporation  as 
the  one  already  described. 

A  close  corporation  of  a  somewhat  different  nature  is 
formed  when  a  person  conducting  a  handsome  business 
which  has  been  assisted  very  materially  by  the  upper 
clerks,  or  by  the  heads  of  departments  within  his  employ, 
says,  "Gentlemen,  I  am  going  to  turn  this  into  a  corpor- 
ation. I  am  going  to  issue  98  per  cent  of  this  stock  to  my- 
self, because  I  own  the  business;  but  you,  Mr.  Jones,  have 
been  wkh  me  for  five  years,  and  you  have  managed  your 
department  well,  so  I  am  going  to  put  $5,000  of  that  stock 
in  your  name,  and  have  you  indorse  it  and  return  it  to  me, 
and  give  me  at  the  same  time  your  note  for  $5,000;  and 
I  will  carry  that  for  you  for  a  reasonable  number  of  years, 
and  let  you  pay  it  off  as  you  please."  In  the  meantime,  of 
course,  Mr.  Jones  gets  the  dividends  on  that  $5,000  worth 
of  stock,  and  the  harder  he  works,  and  the  greater  success 
he  makes  of  the  business,  the  better  for  him,  because  he  is 
one  of  the  participants. 

The  employer  may  divide  up  as  much  as  a  quarter  of 
his  stock  among  four  or  five  trusted  employees,  who  thus 
become  his  partners  in  a  small  way;  and  as  he  gets  older 
and  the  younger  men  take  on  more  of  the  business,  they 
will  perhaps  buy  from  him  other  shares  of  the  stock.  In 
such  a  case  it  can  hardly  be  called  a  very  close  corporation, 
because  these  younger  men  are  in  the  market  for  any  stock 
that  may  be  thrown  there.  When  a  corporation  has 
passed  this  stage  the  market  for  its  stock  gradually  in- 
creases, more  and  more  persons  being  interested  in  it;  and 
if  any  of  the  stock  has  to  be  taken  by  the  bank  for  debt, 


BANK  CREDITS  63 

there  is  always  someone  who  will  buy  it — provided,  of 
course,  that  the  corporation  is  a  success. 

Now  you  see  why  a  bank  cannot  loan  on  the  stock  of  a 
close  corporation.  Such  stock  has  no  general  market;  and 
if,  for  any  reason,  the  holder  of  the  stock  has  to  take  it 
for  the  debt,  the  only  persons  to  whom  he  can  sell  it  are 
the  other  members  of  the  close  corporation.  If  they  do 
not  choose  to  buy  it  from  him,  he  is  helpless.  These  things 
all  have  to  be  considered. 

New  York  Rules 

Banks  in  New  York  have  no  such  rules  in  regard  to  the 
collaterals  that  they  may  accept,  but  merely  require  a  cer- 
tain proportion  of  bonds,  and  a  certain  proportion  of 
stocks  to  be  listed  on  the  Exchange;  and  the  money  is 
loaned  from  day  to  day  on  such  collateral.  But  as  you 
get  away  from  New  York  and  into  the  smaller  places, 
there  is  less  and  less  market  for  any  stock;  and  the  mar- 
ket in  such  a  small  city  may  at  any  time  be  glutted  by  an 
amount  of  some  stock  a  little  over  the  ordinary  thrown 
upon  it.  This  also  has  to  be  considered,  and  a  banker 
who  would  loan  up  to  90  per  cent  of  the  value  of  col- 
lateral in  New  York,  could  not  loan  more  than  75  per 
cent  of  that  value  in  a  place  as  far  from  New  York  as 
Los  Angeles. 


CHAPTER  IV 

FINANCIAL  STATEMENTS,  THEIR  FORM  AND 
ANALYSIS 

BY  HERMAN  FLATAU 

In  the  discussion  of  financial  statements  which  follows, 
the  writer  is  referring  only  to  such  statements  as  come  to 
the  credit  man  of  a  manufacturing  or  wholesale  establish- 
ment, either  direct  from  applicants  for  credit,  or  through 
the  commercial  agencies.  A  few  words  on  credit  methods 
in  general  may,  however,  help  to  make  clear  the  import- 
ance of  this  subject 

Credit  Methods  of  Banks 

As  was  stated  in  the  preceding  chapter,  banks  have  a 
well-established  rule  which  requires  of  an  applicant  for 
credit  a  written  statement  of  his  financial  condition  with 
his  application  for  a  loan.  As  a  rule,  the  merchant  who 
wishes  to  borrow  money  from  a  bank  calls  there  in  per- 
son to  fill  out  this  statement,  and  to  answer  such  other 
questions  about  his  business  affairs  as  the  president  or 
cashier  may  wish  to  ask  him.  Thus  the  banker  has  the 
opportunity  of  coming  into  personal  contact  with  the  ap- 
plicant, and  of  receiving  from  him  direct  a  signed  state- 
ment and  such  other  information  as  is  necessary,  before 
he  passes  upon  the  credit  risk. 

Mercantile  Methods 

But  the  credit  man  of  a  wholesale  house  has  no  such 
advantage.  He  often  receives  an  application  for  credit  in 


FINANCIAL  STATEMENTS  65 

the  shape  of  an  order  from  a  new  customer,  which  his 
salesman  sends  to  him  with  the  injunction,  "Rush  ship- 
ment/' and  the  brief  financial  statement,  "This  man  is 
A— i." 

Knowing  the  eagerness  of  his  house  to  do  as  much 
business  as  possible,  and  being  perhaps  unable  to  get  a 
report  from  the  commercial  agencies  at  once,  he  will  often 
take  a  chance  in  filling  the  first  order — provided,  of  course, 
it  is  not  too  large — upon  the  most  meager  information 
about  the  new  customer's  standing.  Then,  after  the  goods 
have  been  shipped,  he  will  apply  for  a  financial  statement, 
not  to  the  new  customer  direct,  but  through  the  commer- 
cial agencies. 

By  far  the  greater  number  of  financial  statements 
come  through  the  commercial  agencies;  and  while  their 
service  may  not  be  perfect,  the  information  they  furnish  as 
to  the  customer's  antecedents  and  his  known  assets  and 
liabilities,  is  of  the  greatest  value  and  assistance  to  the 
credit  man,  and  well  worth  the  price  paid  for  the  agency 
service. 

Credit  men  do  not,  as  a  rule,  apply  for  a  statement  to 
the  new  customer  direct,  for  the  reason  that  he  will  often 
take  such  a  request  as  a  reflection  upon  his  character  and 
honesty.  There  are  several  causes  for  this  attitude  on  the 
part  of  the  customer.  One  is  that  some  of  those  engaged 
in  the  retail  trade  have  little  knowledge  of  proper  busi- 
ness methods ;  and  another,  that,  on  account  of  the  limited 
territory  to  which  the  wholesaler's  business  is  usually  con- 
fined, the  retail  merchant  is  visited  every  day  by  many 
salesmen  representing  the  same  line  of  goods,  who  are 
eager  to  sell  him  on  the  most  favorable  terms,  and  under 
these  circumstances  he  resents  the  inquiries  of  the  whole- 
sale house.  Still  another,  and  perhaps  the  principal  cause  of 
the  credit  man's  reluctance  to  make  direct  inquiries  as  to 


66  MERCANTILE  CREDITS 

the  new  customer's  standing,  is  due  to  the  lack  of  under- 
standing and  confidence  among  credit  men,  complicated 
by  the  fear  of  losing  a  new  customer.  That  there  are 
comparatively  few  losses,  even  with  such  loose  business 
methods,  speaks  well  for  the  honesty  of  the  men  engaged 
in  the  retail  trade. 

However,  the  steady  growth  of  competition  has  a 
tendency  gradually  to  decrease  profits  and  increase  ex- 
penses ;  therefore,  in  order  to  make  a  net  profit,  the  per- 
centage of  losses  from  book  accounts  will  have  to  be 
reduced,  and  the  credit  man  of  a  wholesale  house  will  in 
time  be  compelled,  like  the  banker,  to  demand  a  correct 
financial  statement  before  the  granting  of  credit  is  con- 
sidered. 

Ordinary  Forms  of  the  Financial  Statement 

The  ordinary  financial  statement  is  a  list  of  all  actual 
assets  and  liabilities  at  a  given  date,  intended  to  show  the 
true  financial  condition  of  a  business.  It  is  usually  ar- 
ranged in  such  form  as  to  show  all  the  assets — that  is,  all 
the  personal  and  real  property  a  firm  owns — upon  one 
side  of  the  sheet,  and  all  liabilities — that  is,  all  the  debts  a 
firm  owes — upon  the  other  side.  The  total  of  each  class 
of  items  comprising  the  assets  is  listed  separately;  as, 
Merchandise;  Accounts  receivable,  good;  Bills  receivable, 
good;  Cash  on  hand;  Cash  in  bank;  Fixtures;  Machinery; 
,  Horses  and  wagons;  Real  estate;  etc.  The  liabilities  are 
also  listed  separately  in  the  same  manner;  as,  Owe  for 
merchandise,  due ;  Owe  for  merchandise,  not  due ;  Notes 
for  merchandise ;  Owe  banks ;  Owe  relatives  and  friends ; 
Owe  for  rent;  Mortgage  on  real  estate;  Chattel  mortgage 
on  fixtures ;  etc.  If  the  total  amount  of  the  assets  is  larger 
than  that  of  the  liabilities,  the  excess  is  the  net  worth  or 
capital  of  the  business.  If  the  sum  total  of  the  liabilities 


FINANCIAL  STATEMENTS  67 

is  greater  than  that  of  the  assets,  the  difference  is  called 
the  deficit.  A  statement  thus  correctly  executed  will  enable 
the  credit  man  to  form  a  fair  estimate  of  the  financial 
strength  of  an  applicant  for  credit. 

Statement  of  the  National  Credit  Men's  Association 

Now  the  object  of  getting  a  statement  is  to  obtain 
such  information  as  will  enable  the  credit  man  to  deter- 
mine the  credit,  if  any,  to  which  a  certain  merchant  is  en- 
titled. Experience,  however,  has  shown  that  the  mere 
knowledge  of  how  much  a  merchant  is  worth  in  dollars 
and  cents  is  not  sufficient  for  safe  credit  granting,  and  that 
in  order  to  act  intelligently  a  credit  man  must  have  addi- 
tional data. 

The  National  Credit  Men's  Association  recognized 
the  need  of  a  financial  statement  blank  not  limited  to  ques- 
tions about  assets  and  liabilities,  but  containing  also  proper 
and  unobjectionable  queries,  calculated  to  elicit  other 
necessary  information.  A  committee  of  the  most  experi- 
enced members  was  appointed  to  draft  such  forms  and 
present  them  to  the  National  Association  for  considera- 
tion; and  of  the  number  submitted,  six  were  indorsed  and 
recommended  by  the  Association.  Two  of  these  forms 
are  here  shown.  The  first  is  sent  by  a  commercial  house 
to  be  filled  out  by  an  individual  or  by  a  partnership  firm, 
and  the  second  is  sent  to  corporations. 

Both  of  these  forms  are  prefaced  by  the  following  brief 
but  forceful  argument,  urging  upon  the  merchant  the  de- 
sirability of  giving  a  signed  statement,  because  in  so  doing 
he  strengthens  and  adds  to  his  credit,  and  also  emphasiz- 
ing the  fact  that  a  merchant's  capital  is  really  his  resources 
plus  his  credit,  and  thus  whatever  adds  to  the  latter  is 
equivalent  to  an  increase  of  capital. 


68  MERCANTILE  CREDITS 

PROPERTY    STATEMENT    BLANK 


RECOMMENDED  AND  INDORSED   BY  THE 
NATIONAL  ASSOCIATION  OF  CREDIT  MEN 

THE  RECIPROCAL  VALVE  OF  A  SIGNED  STATEMENT 

Good  credit  in  the  markets  of  the  world  enables  every  merchant  to 
add  to  his  ability  to  do  business.  It  gives  him  the  use  of  enlarged  capital, 
thus  enabling  him  to  carry  a  more  complete  stock,  increase  his  sales,  and 
magnify  his  profits. 

Large  assets  are  not  always  necessary  to  the  creation  of  credit;  what 
is  most  desirable  is,  that  credit  be  in  relative  proportion  to  the  actual  assets, 
and  in  harmony  with  conditions  which  create  and  maintain  it  A  mer- 
chant's capital  is  the  sum  of  his  net  available  resources,  plus  his  credit  The 
giver  of  credit  is  a  contributor  of  capital,  and  becomes,  in  a  certain  sense, 
a  partner  of  the  debtor,  and,  as  such,  has  a  perfect  right  to  complete  infor- 
mation of  the  debtor's  condition  at  all  times. 

Credit  is  given  a  merchant  because  of  the  confidence  reposed  in  him 
Requesting  a  statement  when  credit  is  asked  is  not  a  reflection  on  one's 
character,  honesty,  or  business  ability,  but  is  done  to  secure  information  to 
enable  business  to  be  conducted  intelligently. 

When  a  statement  is  made  it  should  be  absolutely  correct.  "  To  make 
rt  so  necessitates  the  taking  of  at  least  an  annual  inventory  and  the  keeping 
of  an  accurate  set  of  books.  Statement  giving,  therefore,  will  tend  to 
make  a  debtor  a  better  buyer,  because  more  familiar  with  his  stock,  more 
careful  in  giving  credit,  more  conservative  in  incurring  debt,  and  will  result 
in  a  better  knowledge  of  his  business  generally. 

A  merchant  who  desires  to  serve  his  own  best  interests  should  recog- 
nize that  his  most  valuable  possession,  apart  from  his  actual  assets,  is  a 
sound,  substantial  and  unquestioned  reputation  as  a  credit  risk,  and  that, 
under  the  prevailing  conditions  and  demands  of  business,  the  most  effective, 
and  eminently  the  best  way'to  prove  his  basis  for  credit,  is  to  be  willing  to 
submit  a  statement- of  his  financial  condition. 

NOTE:  The  above  estimate  of  the  value  of-a  statement  to  both  giver  and  receiver  Is  tne 
embodiment  of  the  thoughts  and  experiences  of  scores  of  the  leading  credit  men  of  the  United 
States,  who  are  members  of  the  National  Association  of  Credit  Men,  and  who  tbusdesir* 
ptlblidty  given  to  their  views  in  order  that  there  may  be  the  largest  benefits  to  both  retailer 
and  wholesaler. 

Property  Statement  (Prefatory  page) 


FINANCIAL  STATEMENTS 


69 


For  the  purpose  of  obtaining  credit  for  goods  to  be  sold  me  or  us  by  you,  or  for  any 
extension  granted  me  or  us  on  my  or  our  account  with  you,  the  following  is  given  you  as  a 
true  statement  of  my  or  our  assets  and/liabilities  and  general  financial  condition.  I  or  we 
agree  to  and  wiH  notify  you  immediately  in  writing  of  any  materially  unfavorable  change 
in  my  or  our  financial  condition,  and  in  the  absence  of  such  notice,  or  of  a  new  and  fulj 
written  statement,  this  may  be  considered  as  ^  continuing  statement,  and  substantially 
correct 


Firm  name. Date 

Town County. State 


Value  of  merchandise  on  hand  at  cost. 
Notes  and  accounts,  cash  value 

Cash  te  hand 

Cash  to  bank _ 


^ESS  ASSETS 

Dol 

lars 

Cw 

its 

rf  wagons 

ss  Assets  1 

BUSINESS  LIABILITIES 

Owe  for  mdse.,  open  acct 

of  which  $.. is  past  due 

Owe  on  notes  for  mdse. 

Owe  bank ... 


Owe  others  for  bor*d  money 

Owe  taxes  and  rent 

Mtges. on  fixtures,  machin'y, 
horses  and  wagons 


Total  Business  Liabilities ., 
Net  Worth  in  Business 


LTJ 


OUTSIDE  ASSETS 

Total  real  estate,  assessed  valuation,  $.._ 

Total  encumbrances. ..~...... .........._ $  . 

Equity. 
Personal  property         .---,      


Other  assets.... 

Grand  Total  net  worth  in  and  out  of  Business 

Please  state  location  and  description  of  each  parcel  of  real  estate,  and  cash  valuation 
of,  and  encumbrances  on  each,  and  in  whose  name  each  parcel  is  held- 


Form  A. 


Property  Statement — Individual  or  Partnership  (page  2) 


MERCANTILE  CREDITS 


What  portion  of  real  estate  described  is  homestead? 

Have  you  any  other  debts  than  herein  mentioned? 

Possible  liability  of  each 

Full  given  and  surname  of  each  partner                     Age?     Married?         member  of  nrm  as 
- Indorser,  bondsman,  etc. 

What  kind  of  business  do  you  conduct  ? 

Insurance  on  stock. On  fixtures,  machinery,  horses  and  wagons 

On  real  estate , 

•  Amount  of  sales  last  year Amount  of  expenses 

last  year What  proportion  of  your  sales  is  on  credit? 

How  often  do  you  take  an  inventory  of  stock? Date  of  last  inven- 
tory      If  you  have  borrowed  money  in  the  business,  state 

what  amount  is  secured  and  in  what  way 

.  ^ _ Are  any  merchandise  creditors 

secured  in  any  way? - Have  you  any  judgments,  judgment  notes, 

chattel  mortgages,  or  other  liens  against  you,  recorded  or  unrecorded  ?     If  so,  describe 

Suits  pending  and  of  what  nature-...................^-. 

If  you  have  pledged  or  transferred  outstanding  accounts  or  property 

remaining  under  your  control,  state  amount  thereof  and  amount  received,  or  to  be  received, 

on  account  of  such  pledge  or  transfer. 

Keep  bank  account  with , 

What  books  of  account  do  you  keep? /. 

Buy  principally  from  following  firms : 
Name  Address 

The  above  statement,  both  printed  and  written,  has  been  carefully 
read  by  the  undersigned,  and  is  a  full  and  correct  statement  of  my  or  our 
financial  condition  as  of — 1°1 

By -whom  signed , •— a  member  of  the  firm. 

All  questions  must  *>e  answered,  insert  ciphers  in  absence  of  any  amount.  When  the 
words  "Yes,"  "  No"  or  "  None"  will  correctly  answer  the  questions,  write  them  in  their 
proper  places. 

Property  Statement — Individual  or  Partnership  (page  3) 


FINANCIAL  STATEMENTS 

To  RICH,  MANN  &  CO.,  New 


71 


For  the  purpose  of  obtaining  credit  now  and  hereafter  for  goods  purchased,  we  hero- 
with  submit  to  you  the  following  statement  of  our  resources  and  liabilities,  and  will  im« 
mediately  notify  you  of  any  material  change  in  our  financial  condition. 

In  consideration  of  your  granting  credit  to  the  undersigned,  we  agree  that  in  case  of 
our  failure  or  insolvency,  or  in  case  we  shall  make  any  assignment  for  the  benefit  of  credit- 
ors, bill  of  sale,  mortgage,  or  other  transfer  of  our  property,  or  shall  have  our  stock  or 
plant  attached,  receiver  appointed,  or  should  any  judgment  be  entered  against  us,  then  all 
and  every  of  the  claims  which  you  have  against  us  shall  at  your  option  become  immediately 
due  and  payable,  even  though  the  term  of-cfedit  has  not  expired.  All  goods  hereafter 
purchased  from  you  shall  be  taken  to  be  purchased  subject  to  the  foregoing  conditions  as 
a  part  of  the  terms  of  sale. 


City         .    . 

County 

State.. 

BUSINESS  4 
Value  of  Merchandiseon  hand  at  c 
If  manufacturing,  raw  material,  $... 

ASSETS 
ost 

Dollars 

Cents 

finished,  $  

Notes  and  accounts,  cash  valu 
Cash  in  hand 

Bills  or  accounts  receivable,  due  from  office 
Patents  and  patterns 

-v 

Total  real  estate,  cash  value 
Total  encumbrances  on  real  « 

Total  Active  Busit 

BUSINESS  LIABILITIES. 
Owe  for  mdse.,  open  acct., 
of  which  $  is  past  due 

$ 

istate,  $ 
ess  As. 

Equi 
sets.  

ty  

II 

I 

IJ 

Dollars 

Cents 

Owe  for  bills  for  paper  sold 
Owe  others  for  bor'd  money 

Mtgs.  on  fixt's  and  mach'y 

Total  Business  Liabilities- 
Total  net  worth  .  

II 

1 

i  .11 

|| 

i       1 

|.   1! 

Please  state  location  and  description  of  each  parcel  of  real  estate,  and  cash  valuation 
!(»£,  and  encumbrances  on,  each — 


Property  Statement — Corporation  (page  2) 


72  MERCANTILE  CREDITS 

'  Accommodation  indorsements — ^ 


Contingent  Liability^ 

'.Indorsed  bills  receivable  and  outstanding. 


OFFICERS. 
Name  in  Full  Address 


President  ... 
Vice-Prest  ... 
Secretary  ... 
Treasurer  ... 


DIRECTORS. 

Name  in  Full  Address 


Authorized    capital Subscribed Paid  in 

How  paid  in:  Cash,  $ _ Other  property Description  of 

other  property,  and  how  valued 

In  whose  name  is  title  to  real  estate  held? 

Incorporated  in  what  State  and  under  what  general 

laws  or  special  act? Nature  of   business? 

Date  of  charter? -..Suits  pending,  and  of  what  nature? 

Are  any  merchandise  creditors  secured  in  any 

way? Amount  of  annual  business Annual  expenses 

'Annual  dividends When   was  last  dividend  declared  ? Rate 

Insurance  carried  on  merchandise Fixtures  and  machinery 

Real  estate. Regular  time  of  taking  inventory... Keep 

bank    accounts    with ..............t................................... 

Keep-    following   books    of    account _ „ 

If  you  have  pledged  or  transferred  outstanding  accounts  or  property  remaining-  under 
your  control,  state  amount  thereof  and  amount  received,  or  to  be  received,  on  account  of 
such  pledge  or  transfer „ 

Buy  principally  from  following  firms  : 


Name 


Address 


What  Hne  of 
business  ? 


The  above  statement,  both  printed  and  written,  has  been  carefully  read  by  the 
undersigned,  and.  is    a   full   and  correct   statement  of    our   financial    condition  as  of 


Corporation  Signature 
By 
Date  ..................  -.  .......................  -  ...... 


All  questions  must  be  answered,  insert  ciphers  in  absence  of  any  amount.  When  th* 
words  "Yes,"  "No"  or  "None"  will  correctly  answer  the  questions,  write  them  in  their 
proper  places. 

Property  Statement  —  Corporation  (page  3) 


FINANCIAL  STATEMENTS  73 

It  will  be  noted  that  the  corporation  statement  differs 
from  the  other  in  the  character  of  the  questions  asked. 
These  indicate  how  important  and  intricate  is  the  organi- 
zation of  capital  in  corporations;  and  the  facts  intended 
to  be  elicited  are  of  particular  interest  and  importance  to 
the  credit  man. 

Reports  of  the  Commercial  Agencies 

Now,  while  these  statements  contain  considerably 
more  information  than  the  ordinary  statement  covering 
only  assets  and  liabilities,  yet,  coming  from  the  applicant 
direct,  they  cannot  and  do  not  enlighten  us  as  to  his  own 
moral  and  mental  make-up.  For  this  information  we  gen- 
erally look  to  the  commercial  agencies ;  and  it  is  here  that 
their  importance  becomes  apparent  to  the  credit  man. 
The  agency  report  is  considered  at  length  in  another 
chapter. 

The  Credit  Risk 

Having  now  before  us  a  standard  form  of  financial 
statement,  let  us  briefly  consider  the  line  of  reasoning  the 
credit  man  must  follow  and  the  business  knowledge  he 
must  have  in  order  to  be  able  to  analyze  such  a  statement 
properly  and  reach  a  wise  decision  as  to  the  giving  or  re- 
fusing of  credit. 

There  is  more  or  less  risk  in  all  credit  transactions, 
and  to  discriminate  between  different  degrees  of  risk  is  the 
difficult  task  of  the  credit  man.  If  his  duty  were  simply  to 
avoid  losses,  then  he  would  merely  have  to  decline  any 
account  that  was  in  the  least  doubtful.  But  this,  of  course, 
would  reduce  the  volume  of  business  of  his  house  to  a 
minimum;  and  since  the  ever-increasing  competition  cuts 
down  profits  and  raises  expenses,  a  wholesale  house  must 
do  a  certain  volume  of  business  every  year  in  order  to 


74  MERCANTILE  CREDITS 

show  a  fair  amount  of  net  profit.  Hence,  it  becomes  the 
duty  of  the  credit  man  to  secure  the  maximum  volume  of 
business  with  the  minimum  amount  of  losses. 

Qualifications  of  the  Credit  Man 

To  be  able  to  do  this  he  must  have  experience  and 
ability.  He  must  be  a  good  judge  of  human  nature — able 
to  form  a  correct  estimate  of  those  moral  and  Intellectual 
assets  of  an  applicant  which  are  of  even  greater  import- 
ance in  determining  the  credit  risk  than  are  the  financial 
assets.  He  must  know  how  to  analyze  and  to  strike  a  bal- 
ance of  the  moral  and  financial  standing  of  a  customer. 
He  should  have  a  good  knowledge  of  accounting,  so  that 
he  can  detect  the  weak  spots  in  a  statement,  and,  if  neces- 
sary, verify  the  figures  by  a  comparison  with  the  books  of 
the  applicant.  He  should  have  a  fair  knowledge  of  the 
laws  affecting  credits  in  the  various  states  in  which  he  is 
doing  business,  and  should  especially  be  posted  as  to  the 
amount  allowed  under  exemption  laws.  He  should  be 
fairly  well  informed  as  to  values  of  merchandise,  so  that 
he  will  be  able  to  approximate  the  amount  of  stock  a  mer- 
chant carries.  Finally,  he  should  be  familiar  with  local 
conditions  in  the  different  places  where  his  customers  are 
doing  business. 

Character  of  Applicant 

When  we  apply  the  rules  of  analysis  to  business,  we 
find  that  success  and  safety  are  dependent  upon  the  exist- 
ence and  proper  combination  of  certain  elements.  Each 
one  of  these  is  an  important  factor  in  the  consideration  of 
credit,  though  some  are  of  more  consequence  than  others. 
Among  the  most  important  are  the  character,  honesty,  and 
habits  of  the  applicant  for  credit;  and  deficiency  in  any  one 
of  these  makes  the  risk  dangerous.  Therefore,  the  credit 


FINANCIAL  STATEMENTS  75 

man  should  carefully  inquire  into  the  personal  record  of 
the  applicant.  A  man  whose  character  is  bad,  who  is  dis- 
honest, or  who  is  addicted  to  drink,  is  not  entitled  to  our 
confidence.  We  give  a  man  credit  because  we  have  con- 
fidence in  him,  and  we  base  our  confidence  in  him  upon  his 
character,  honesty,  and  habits;  therefore,  if  these  are  not 
good,  there  remains  no  basis  for  credit. 

Ability  as  a  Credit  Factor 

But,  though  good  personal  character  in  an  applicant  is 
of  the  greatest  importance  to  the  creditor,  this  alone  does 
not  assure  the  success  of  a  business.  There  are  many 
cases  £>n  record  where  men  of  fine  character  and  habits  and 
absolute  honesty  have  failed  in  business  because  of  the 
lack  of  ability.  Consequently,  to  insure  the  safety  of 
credit  transactions,  the  factor  of  ability  must  be  added  to 
those  already  mentioned.  A  merchant's  ability  is  deter- 
mined by  the  efficiency  and  the  economy  of  his  business  or- 
ganization; by  his  knowledge  of  the  cost  of  goods;  by  his 
selection  of  the  articles  that  his  trade  requires  in  quanti- 
ties that  will  not  overstock  him ;  by  the  amount  of  business 
he  does  and  the  profit  he  makes ;  by  judicious  selling  on 
credit  and  prompt  attention  to  his  collections. 

If  the  credit  man  is  absolutely  certain  of  the  existence 
of  all  these  qualities  in  the  applicant,  he  need  but  give  pass- 
ing notice  to  the  items  on  the  financial  statement.  In  fact, 
many  a  merchant  got  his  start  upon  no  other  assets  but 
these.  But,  unfortunately,  these  moral  and  mental  en- 
dowments are  not  always  present  in  an  applicant  in  such 
measure  as  to  warrant  the  acceptance  of  the  risk.  And 
thus  it  is  necessary  to  make  a  close  analysis  of  the  items 
comprising  the  physical  assets  and  liabilities  before  reach- 
ing a  final  decision  as  to  the  amount  of  credit  to  be  given. 


76  MERCANTILE  CREDITS 

Careless  Bookkeeping 

In  making  any  such  estimate  of  the  net  worth  of  a 
retailer  it  is  well  to  bear  in  mind  that  some  merchants  are 
careless  in  their  method  of  keeping  their  books,  and  that 
others  do  not  keep  any  at  all;  thus  the  amounts  of  the 
various  items  on  their  statements  are  not  always  correct, 
and  sometimes  represent  merely  an  appraisal  of  assets  and 
liabilities.  Therefore,  when  we  have  reason  to  believe 
that  the  statement  received  comes  from  a  man  who  is  care- 
less in  his  bookkeeping,  we  must  be  more  liberal  in  our 
allowance  for  shrinkage  in  the  assets  and  for  growth  in  the 
liabilities.  Credit  men  have  often  had  occasion  to  note 
the  generous  manner  in  which  some  merchants  estimate 
the  value  of  their  assets,  and  how  niggardly  they  are  in 
stating  their  liabilities. 

Valuation  of  Stock 

But  let  us  assume  that  the  statement  is  compiled  from 
books  correctly  kept.  The  first  item  for  analysis  will  be : 
"Merchandise  on  hand  at  cost."  In  appraising  the  value 
of  a  stock  with  a  view  of  granting  credit,  we  must  bear  in 
mind  the  possibility  of  a  failure,  especially  when  the  net 
worth  shown  by  the  statement  is  only  of  moderate  amount. 
Experience  has  indicated  that  in  cases  of  failure  a  stock 
consisting  of  staple  goods,  such  as  groceries,  etc.,  located 
in  a  place  where  it  can  readily  be  sold,  will  bring  from  60 
to  75  cents  on  the  dollar  of  invoice  price.  The  stock  of  a 
going  concern,  of  course,  is  worth  more;  therefore,  an 
allowance  of  say  15  to  25  per  cent  on  a  staple  stock  will 
give  us  a  conservative  figure.  But  in  considering  the 
amount  that  should  be  deducted  to  arrive  at  a  safe  valu- 
ation, we  must  also  notice  the  character  of  the  merchan- 
dise, the  condition  it  is  in,  whether  it  is  slow-selling  or  can 
quickly  be  turned  into  cash. 


FINANCIAL  STATEMENTS  77 

Notes  and  Accounts 

The  next  item  is :  "Notes  and  accounts."  If  we  com- 
pare the  amount  outstanding  with  the  amount  of  monthly 
credit  business,  we  shall  be  able  to  judge  whether  the  mer- 
chant is  a  close  collector  or  not,  and  upon  this  will  depend 
the  amount  that  should  be  retired  on  account  of  age.  At 
any  rate  an  allowance  of  30  to  40  per  cent  should  be  made 
for  shrinkage. 

Cash 

The  next  item  is :  "Cash  in  hand."  This,  of  course,  is 
not  subject  to  any  depreciation  if  it  consists  of  actual 
money,  and  not  of  checks  that  are  dated  ahead  or  have 
been  returned  on  account  of  lack  of  funds.  Then  comes: 
"Cash  in  bank."  In  regard  to  this  item,  we  must  bear  in 
mind  the  fact  that,  if  the  merchant  is  indebted  to  the  bank 
where  he  deposits,  such  bank  has  the  legal  right  to  retain 
any  cash  or  other  personal  property  in  its  possession  be- 
longing to  the  debtor,  and  to  apply  it  toward  the  payment 
of  the  debt. 

"Quick"  and  "Slow"  Assets 

The  foregoing  items — merchandise,  notes  and  ac- 
counts receivable,  cash  in  hand  and  in  bank — comprise 
what  are  generally  called  the  quick  assets,  so  named  be- 
cause they  can  be  more  quickly  turned  into  cash  than  the 
fixed  or  slow  assets,  which  usually  consist  of  fixtures,  store 
furniture,  machinery,  horses,  wagons,  etc.  While  these 
latter  may,  and  often  do,  represent  a  considerable  outlay 
of  money,  yet  as  a  basis  for  credit  their  value  should  be 
considered  nominal.  A  deduction  of  50  per  cent,  at  least, 
should  be  made. 


;8  MERCANTILE  CREDITS 

Liabilities 

Now,  when  we  come  to  consider  the  liabilities,  we 
know  from  experience  that  every  dollar  listed  means  100 
cents  that  must  be  paid,  and  often  more  than  that.  The 
amounts  "Past  due  for  merchandise"  and  "Owe  on  notes 
for  merchandise"  should  be  carefully  noted,  as  these  gen- 
erally indicate  unsatisfactory  payments.  An  indebtedness 
for  back  rent,  or  a  chattel  mortgage  on  fixtures  or  horses 
and  wagons  is  a  sure  sign  of  financial  weakness. 

Outside  Assets 

The  various  items  heretofore  mentioned  are  called  the 
business  assets  and  business  liabilities.  We  now  come  to 
"Outside  assets,"  such  as,  "Total  real  estate." 

Real  property,  no  doubt,  strengthens  the  assets,  pro- 
vided it  is  free  of  encumbrance,  stands  in  the  name  of  the 
applicant,  brings  a  fair  return  on  the  investment  or  is  at 
least  self-supporting,  and  is  not  subject  to  homestead  ex- 
emption. Credit  men  are  sometimes  misled  by  the  sched- 
uling of  a  store  building  under  assets,  when  as  a  fact  the 
building  is  used  for  business  and  also  for  dwelling  pur- 
poses, which  latter  fact  brings  it  under  the  head  of  ex- 
emptions. If  the  real  estate  is  mortgaged,  the  equity  as  a 
rule  is  not  worth  considering  from  a  credit  standpoint. 

Personal  Property  and  Other  Assets 

The  next  items,  "Personal  property"  and  "Other  as- 
sets," are  generally  of  such  a  nature  as  to  be  of  little  or  no 
interest  to  creditors.  The  object  of  the  other  questions, 
such  as :  "What  portion  of  real  estate  described  is  home- 
stead?" or,  "Have  you  any  other  debts  than  herein  men- 
tioned?" is,  of  course,  plain. 


FINANCIAL  STATEMENTS  79 

Names  of  Partners  or  Officers 

Then  comes:  "Full  given  name  and  surname  of  each 
partner."  It  is  certainly  of  great  importance  to  the  credit 
man  to  know  who  is  responsible  for  the  debts  of  a  busi- 
ness ;  therefore,  he  should  carefully  note  that  this  question 
is  satisfactorily  answered.  The  name  of  the  firm  does  not 
always  indicate  the  actual  person  or  persons  interested  in 
the  business,  and  as  each  partner  in  a  partnership  firm  is 
responsible  for  the  entire  indebtedness  of  the  firm,  it  is 
well  to  know  the  name  of  each  one.  Some  stores  operate 
under  an  assumed  or  fictitious  name,  in  some  cases  re- 
sembling that  of  a  responsible  business  man.  In  order  to 
safeguard  credit  grantors,  a  law  has  been  enacted  in  some 
states  requiring  that  every  person  or  partnership  conduct- 
ing business  under  a  fictitious  name,  or  a  designation  not 
showing  the  names  of  the  persons  interested  as  partners  in 
such  business,  must  file  with  the  clerk  of  the  county  in 
which  his  or  its  principal  place  of  business  is  situated,  a 
certificate  stating  the  name  in  full  and  the  place  of  resi- 
dence of  such  person,  and  also  stating  the  names  in  full 
of  all  the  members  of  such  partnership  and  their  places  of 
residence.  If  the  business  is  incorporated,  a  complete  list 
of  all  the  officers  should  be  obtained,  together  with  a  list 
of  the  number  of  shares  each  one  owns,  and,  if  possible, 
the  names  of  other  large  shareholders.  In  some  states 
each  stockholder  in  a  corporation  is  responsible  for  a  per- 
centage of  the  indebtedness  proportionate  to  the  number 
of  shares  he  owns. 

Personal  Status 

The  next  facts  required  are:  "Age"  and  "Married." 
The  age  of  a  merchant  is  not  an  unimportant  element  in 
determining  his  claim  for  credit.  After  a  man  has  passed 
his  prime,  his  energy  and  ambition  as  a  rule  are  on  the 


80  MERCANTILE  CREDITS 

decline.  If  he  has  not  been  able  to  accumulate  at  least  a 
fair  amount  of  capital  during  the  best  years  of  his  life,  it 
is,  with  few  exceptions,  due  to  the  fact  that  he  is  a  failure 
as  a  business  man.  And  again,  if  a  man  is  very  young,  he 
lacks  in  most  instances  the  experience  which  is  necessary 
to  conduct  a  business  successfully.  It  is  also  important  to 
know  whether  the  merchant  is  married  or  single,  for  upon 
that  depends  the  amount  to  which  he  is  entitled  under  the 
exemption  laws. 

Insurance 

The  next  information  required  is:  "Insurance  on 
stock,  fixtures  and  real  estate."  Among  the  elements  con- 
sidered by  credit  men  in  determining  the  credit  risk,  per- 
haps none  has  received  less  attention  than  that  of  fire  in- 
surance. The  ability  of  the  retail  merchant  to  pay  his 
debts  in  case  he  suffers  a  heavy  loss  by  fire,  depends 
usually  upon  the  amount  of  insurance  he  carries.  If  his 
stock,  fixtures,  or  buildings  are  not  sufficiently  insured,  or 
perhaps  not  at  all,  the  loss,  in  the  absence  of  outside 
means,  usually  falls  on  the  creditors.  The  National  Asso- 
ciation of  Credit  Men,  whose  principal  object  is  to  im- 
prove credit  conditions,  has  presented  many  articles  on  the 
subject  of  insurance  in  the  Bulletin  of  the  Association,  and 
has  thus  gradually  impressed  upon  its  members  the  im- 
portance of  knowing  something  about  the  amount  of  fire 
insurance  carried  by  their  customers.  It  has  also  urged 
upon  them  and  upon  the  commercial  agencies  the  necessity 
of  persuading  the  retailer  to  protect  his  credit  by  carrying 
reliable  fire  insurance  of  sufficient  amount.  Considerable 
improvement  in  this  respect  has  resulted  from  the  cam- 
paign of  education. 


FINANCIAL  STATEMENTS  81 

Sales  and  Expenses 

The  next  information  required  is :  "Amount  of  sales 
last  year"  and  "Amount  of  expenses  last  year."  By  com- 
paring the  total  of  expense  with  that  of  the  sales,  we  can 
judge  if  the  expenses  are  in  proper  proportion  to  the  aver- 
age gross  profits — in  other  words,  whether  the  retailer  is 
making  a  net  profit.  The  merchant  who  keeps  his  ex- 
penses within  proper  limits  is  generally  careful  in  all  other 
matters.  Then,  again,  a  comparison  of  his  average 
monthly  sales  with  the  amount  of  stock  carried  will  indi- 
cate whether  he  is  a  careful  buyer.  Overbuying  is  often 
the  cause  of  failure. 

Credit  Sales 

Next  comes :  "What  proportion  of  sales  is  on  credit?" 
Many  retail  merchants  get  into  difficulties  on  account  of 
selling  too  much  on  credit  in  proportion  to  their  business 
capital.  The  amount  of  their  credit  business  should  not 
be  so  large  that  they  cannot  meet  their  obligations  when 
due. 

Inventories 

The  next  fact  required  is :  "Date  of  last  inventory." 
It  is  surprising  how  few  of  those  engaged  in  the  retail 
business  seem  to  understand  the  importance  of  an  annual 
inventory.  A  financial  statement  coming  from  an  appli- 
cant who  seldom  or  never  takes  an  inventory  cannot  be 
reliable,  as  it  merely  represents  a  guess ;  but  if  he  is  in  the 
habit  of  taking  an  annual  inventory,  the  indications  are 
that  he  is  conducting  his  business  intelligently.  The  care- 
ful merchant  will  want  to  know  at  least  once  in  twelve 
months  his  exact  financial  condition,  and  his  profits  in  pro- 
portion to  the  amount  of  business  he  has  done. 

The  reasons  for  the  other  questions  on  the  statement 


82  MERCANTILE  CREDITS 

are  perfectly  clear,  and  further  comment  is  unnecessary. 
It  should  be  carefully  noted  that  the  statement  is  properly 
dated  and  signed,  as  otherwise  it  is  of  little  value,  and 
entirely  worthless  in  cases  of  fraudulent  failure. 

Character  Comes  First 

When  we  have  in  this  way  carefully  analyzed  the 
moral,  mental,  and  financial  worth  of  the  applicant,  we 
come  to  the  point  when  we  must  decide  upon  the  amount 
of  credit  to  which  he  is  entitled,  always  remembering  that, 
as  before  stated,  the  credit  man  must  inevitably  be  gov- 
erned almost  as  much  by  the  moral  and  intellectual  make- 
up of  each  individual  applicant  as  by  the  amount  of  capital 
he  has.  Experience  only,  and  a  close  study  of  human 
nature,  can  give  us  the  ability  to  judge  how  far  we  may 
safely  go.  There  is,  however,  one  fundamental  rule  which 
will  apply  to  all  cases,  and  which  credit  men  should  always 
bear  in  mind  when  gauging  the  credit  risk,  and  that  is, 
that  character  and  ability  come  first. 

Legal  Punishment  for  False  Statements 

The  practice  of  exacting  and  giving  property  state- 
ments has  become  more  or  less  established;  and  an  effort 
is  now  being  made  to  throw  such  sanctity  about  this  instru- 
ment as  will  give  the  safety  that  credit  granting  demands. 
While  every  state  has  some  form  of  statute  for  the  punish- 
ment of  offenders  who  obtain  money  or  property  by  means 
of  false  pretenses  or  representations,  such  statutes  have 
proved  inadequate  in  most  cases  where  the  fraud  was  per- 
petrated in  connection  with  a  false  statement  of  condition. 
Experience  having  thus  shown  that  a  special  statute  upon 
this  particular  subject  is  necessary,  the  American  Bank- 
ers' Association  and  the  National  Association  of  Credit 
Men  have  joined  hands  to  secure  in  every  state  a  law 


FINANCIAL  STATEMENTS  83 

penalizing  the  giving  of  a  written  false  statement,  such 
law  to  cover  all  cases  of  the  making  of  false  statements 
to  obtain  property  or  credit  in  any  form,  whether  such 
statements  are  made  directly  to  the  one  from  whom  it  is 
sought  to  obtain  the  property  or  credit,  or  indirectly,  as 
to  a  mercantile  agency,  to  be  referred  to  by  the  merchant 
who  sells  goods. 

The  bill  brought  forward  in  the  California  State  Leg- 
islature may  be  quoted  as  an  illustration.  It  reads  as 
follows : 

AN  ACT  to  punish  the  making  or  use  of  false  statements 
to  obtain  property  or  credit. 

(Wherever  a  Penal  Code  or  Consolidated  Law  is  in  force,  the  following  should  be  in- 
serted as  a  section  in  its  appropriate  place.  Where  no  such  Code  exists,  the  act  may 
properly  be  enacted  as  a  new  act,  entitled  as  above.) 

Be  it  enacted,  etc. 

SECTION  1.    Any  person, 

(1)  Who  shall  knowingly  make  or  cause  to  be  made,  either 
directly  or  indirectly,  or  through  any  agency  whatsoever,  any  false 
statement  in  writing,  with  intent   that  it  shall  be  relied  upon,  re- 
specting the  financial  condition,  or  means  or  ability  to  pay,  of  him- 
self, or  any  other  person,  firm  or  corporation,  in  whom  he  is  inter- 
ested, or  for  whom  he  is  acting,  for  the  purpose  of  procuring  in 
any  form  whatsoever,  either  the  delivery  of  personal  property,  the 
payment  of  cash,  the  making  of  a  loan  or  credit,  the  extension  of 
a  credit,   the   discount  of   an   account   receivable,   or   the   making, 
acceptance,  discount,  sale  or  endorsement  of  a  bill  of  exchange,  or 
promissory  note,  for  the  benefit  of  either  himself  or  of  such  person, 
firm  or  corporation;  or 

(2)  Who,  knowing  that  a  false  statement  in  writing  has  been 
made  respecting  the  financial  condition  or  means  or  ability  to  pay, 
of  himself,   or  such   person,   firm   or   corporation  in   which   he   is 
interested,   or   for   whom   he   is    acting,   procures,   upon   the    faith 
thereof,  for  the  benefit  either  of  himself,  or  of  such  person,  firm  or 
corporation,  either  or  any  of  the  things  of  benefit  mentioned  in  the 
first  subdivision  of  this  section;  or 


84  MERCANTILE  CREDITS 

(3)  Who,  knowing  that  a  statement  in  writing  has  been  made, 
respecting  the  financial  condition  or  means  or  ability  to  pay  of 
himself  or  such  person,  firm  or  corporation,  in  which  he  is  inter- 
ested, or  for  whom  he  is  acting,  represents  on  a  later  day,  either 
orally  or  in  writing,  that  such  statement  theretofore  made,  if  then 
again  made  on  said  day,  would  be  then  true,  when  in  fact,  said 
statement  if  then  made  would  be  false,  and  procures  upon  the  faith 
thereof,  for  the  benefit  either  of  himself  or  of  such  person,  firm  or 
corporation,  either  or  any  of  the  things  of  benefit  mentioned  in  the 
first  sub-division  of  this  section: 

Shall  be  guilty  of  a  felony,  punishable  by  (insert  amount  of  fine, 
term  of  imprisonment  or  both). 

Federal  Decisions 

The  Federal  Government  has  also  entered  into  a  vig- 
orous campaign  against  those  who  are  using  the  mails  for 
sending  false  financial  statements  in  order  to  obtain  credit. 
A  notable  case  of  this  kind  was  tried  about  a  year  ago  in 
one  of  the  Federal  Courts  in  the  state  of  New  York.  The 
charge  was  based  upon  financial  statements  of  the  defend- 
ant's concern  signed  by  himself,  and  sent  through  the 
mails  to  a  wholesale  dry-goods  firm  and  to  the  commercial 
agencies.  The  latter  issued  them  to  subscribers,  and  the 
subscribers  in  turn  extended  credit  to  the  firm  on  the 
strength  of  these  statements.  A  representative  of  the 
dry-goods  firm  exhibited  envelopes  in  which  he  said  the 
various  financial  statements  of  the  defendant's  firm  had 
been  received  through  the  mails.  Important  testimony 
was  given  by  an  expert  representing  the  department  of  jus- 
tice, who  showed  that  an  examination  of  the  books  of  the 
defendant's  firm  revealed  an  average  difference  of  $65,- 
ooo  between  the  figures  of  the  firm's  books  and  the  finan- 
cial statement  of  the  firm's  condition  submitted  to  the  cred- 
itors and  commercial  agencies.  He  reported  that  there 
was  an  apparent  insolvency  of  $5,800. 

The  attorney  for  the  defense  pleaded  that  never  before 
had  a  case  of  the  kind  been  tried  in  any  court;  that  the 


FINANCIAL  STATEMENTS  85 

indictment  was  founded  on  a  postal  law  of  1873,  which 
had  been  passed  to  stop  frauds  such  as  gold  brick  and 
green  goods  schemes,  fake  medical  advertisements,  etc.; 
and  that  no  one  at  the  time  of  the  drafting  of  the  law 
expected  that  it  would  be  used  against  a  merchant  doing  a 
legitimate  business,  who  might  have  mailed  a  few  finan- 
cial statements  which  on  analysis  were  found  to  be  over- 
optimistic  or  exaggerated.  He  said  that  Section  215  of 
the  Criminal  Code  of  the  United  States  has  been  looked 
upon  by  the  legal  fraternity  all  along  as  applying  to  fake 
mining  schemes  and  get-rich-quick  propositions,  and  that 
it  would  be  a  very  dangerous  matter  to  broaden  the  mean- 
ing of  the  law  to  include  financial  statements,  which,  if  put 
to  the  test  of  expert  analysis,  might  be  found  in  a  multi- 
tude of  cases  to  be  a  shade  more  favorable  than  the  actual 
conditions  warranted,  yet  might  be  made  by  men  uncon- 
scious of  fraud,  and  entirely  innocent  of  wilful  intent  to 
deceive. 

In  charging  the  jury,  the  judge  who  presided  at  the 
trial,  in  interpreting  Section  215,  said  that,  if  it  were  the 
intent  of  the  defendant  to  defraud  creditors  or  those  about 
to  become  creditors  of  his  firm  by  making  false  representa- 
tions, then  it  was  the  duty  of  the  jury  to  bring  in  a  verdict 
of  "guilty";  that  a  false  or  misleading  statement  made 
through  gross  carelessness  or  lack  of  knowledge  of  figures 
to  mislead  others,  in  order  to  secure  property  belonging 
to  others,  is  a  false  representation.  The  jury  brought  in 
a  verdict  of  "guilty."  In  passing  sentence  of  imprison- 
ment for  one  year  and  three  months  in  the  Federal  pen- 
itentiary, the  judge  declared  that  he  wanted  it  generally 
known  among  those  who  were  inclined  to  do  as  the  de- 
fendant had,  that  there  is  a  law  and  a  certainty  of  punish- 
ment necessary  for  the  public  good  and  as  a  deterrent  to 
others. 


86  MERCANTILE  CREDITS 

Section  215  of  the  U.  S.  Criminal  Code  under  which 
the  defendant  was  convicted  reads  as  follows : 

Use  of  Mails  to  Promote  Frauds.  The  Criminal  Code  of  the 
United  States. 

Sec.  215.  Whoever,  having  devised  or  intending  to  devise  any 
scheme  or  article  to  defraud,  or  for  obtaining  money  or  property 
by  means  of  false  or  fraudulent  pretenses,  representations,  or 
promises,  etc.,  shall  for  the  purpose  of  executing  such  schemes  or 
artifice,  or  attempting  so  to>  do,  place,  or  cause  to  be  placed,  any 
letter,  postal  card,  package,  writing,  circular,  pamphlet,  or  adver- 
tisement, whether  addressed  to  any  person  residing  within  or  out- 
side the  United  States,  in  any  post-office,  or  station  thereof,  or 
street  or  other  letter  box  of  the  United  States,  or  authorized  de- 
pository for  mail  matter,  to  be  sent  or  delivered  by  the  Post  Office 
establishment  of  the  United  States,  or  shall  take  or  receive  any 
such  therefrom,  whether  mailed  within  or  without  the  United 
States,  or  shall  knowingly  cause  to  be  delivered  by  mail  according 
to  the  direction  thereon,  or  at  the  place  at  which  it  is  directed  to  be 
delivered  by  the  person  to  whom  it  is  addressed,  any  such  letter, 
postal  card,  package,  writing,  circular,  pamphlet,  or  advertisement, 
shall  be  fined  not  more  than  one  thousand  dollars,  or  imprisoned 
not  more  than  five  years,  or  both. 


CHAPTER  V 
COMMERCIAL  AGENCIES  AND  REPORTS 

BY  E.  R.  PURDY 

Primitive  Methods 

By  way  of  preface  to  the  subject  of  mercantile  agen- 
cies, it  may  be  well  to  review  briefly  the  history  of  these 
agencies,  and  the  conditions  which  existed  previous  to 
their  establishment. 

There  was  a  time  when  mercantile  transactions  were 
unknown,  when  every  man — if  he  could — took  what  he 
wanted  from  his  fellow-man  under  the  simple  law  of  plun- 
der. Then,  as  civilization  advanced  there  came  the  era  of 
barter,  which,  however,  involved  no  granting  of  time  for 
payment,  no  question  of  credit.  Exchange  was  in  kind, 
commodity  for  commodity,  and  each  transaction  was  as 
simple,  brief,  and  individual  as  the  swapping  of  school- 
boy jack-knives. 

The  Beginnings  of  Commerce 

With  the  development  of  the  more  civilized  instincts 
of  mankind,  fostered  by  a  growing  recognition  of  the  ad- 
vantages of  peace,  there  came  a  great  advancement  in  all 
industrial  arts,  followed  by  an  immense  production  of 
everything  required  to  meet  the  demands  of  necessity,  or 
to  satisfy  the  craving  for  luxury.  These  conditions  led  to 
the  establishment  of  trade  relations  between  nation  and 
nation,  until  gradually  the  system  of  barter  disappeared, 
and  in  its  place  came  a  broader  and  more  enlightened 
commerce. 

87 


88  MERCANTILE  CREDITS 

Necessity  of  Credit 

But  even  then,  goods  were,  as  a  rule,  delivered  only 
for  immediate  cash,  as  is  clearly  indicated  by  medieval 
account  books.  However,  as  commercial  relations  became 
extended  and  complex,  the  necessity  for  credit  was  grad- 
ually forced  upon  those  engaged  in  the  larger  enterprises; 
and  while  for  centuries  the  credit  methods  employed  were 
crude,  yet  by  their  use  individuals  and  nations  prospered 
and  added  greatly  to  the  material  wealth  of  the  world. 

Complexity  of  Modern  Credit  Relations 

This  condition  continued  with  but  little  change  for  a 
long  period;  in  fact,  up  to  the  time  of  the  beginning  of 
American  development  during  the  last  century.  At  this 
time,  the  rapid  growth  of  the  United  States  and  Canada, 
their  great  extent,  the  marvelous  enterprise  of  the  people, 
the  resulting  mercantile,  agricultural,  and  mineral  develop- 
ment, and  many  other  related  causes,  all  combined  to  pro- 
duce conditions  which  had  never  before  existed  nor  been 
possible  in  the  history  of  the  world.  In  connection  with 
all  this,  the  great  geographical  separation  of  debtor  and 
creditor,  the  distance  between  commercial  centers,  and  the 
length  of  time  required  for  transportation,  ultimate  de- 
livery of  goods  and  remittances,  imperatively  demanded 
some  system  of  investigation  as  a  guide  for  extending 
credit.  It  is  therefore  not  improper  to  say  that  the  work 
of  the  mercantile  agency  in  its  present  state  of  develop- 
ment and  extension  is  a  natural  and  logical  evolution  from 
a  commercial  necessity. 

Early  Credit  Conditions 

Previous  to  the  late  '405,  no  intelligent  and  general 
system  of  reporting  mercantile  credits  had  been  attempted. 


COMMERCIAL  AGENCIES  AND  REPORTS     89 

There  had  been  no  scientific  study  of  this  most  vital  factor 
in  our  commercial  progress;  methods  were  crude;  in- 
formation regarding  customers  was  too  often  obtained  by 
creditors  from  untrustworthy  or  prejudiced  sources  and 
in  a  haphazard  way;  finally,  the  time  limits  of  payment 
were  irregular  and  marked  by  an  unwise  over-indulgence 
to  debtors  with  consequent  disaster  to  creditors.  All  this 
pointed  so  clearly  to  the  need  for  better  credit  methods 
that  the  establishment  of  the  mercantile  agency  was  a  nat- 
ural sequence. 

Growth  of  Mercantile  Agencies 

The  credit  methods  employed  in  the  early  days  of 
Bradstreet's  would  now  be  condemned.  The  ratings  were 
at  first  merely  published  on  loose  sheets  and  distributed  to 
subscribers.  But  in  August,  1857,  the  first  reference  book 
published  by  a  mercantile  agency  appeared.  It  was  an 
annual,  and  consisted  of  only  56  pages,  with  ratings  in 
certain  stipulated  lines  in  New  York,  Boston,  Philadel- 
phia, Pittsburgh,  Cincinnati,  Chicago,  and  St.  Louis. 
Later,  semi-annuals  were  published  in  January  and  July; 
and  later  still,  what  were  called  second  editions,  in  March 
and  September,  in  which  appeared  such  changes  as  could 
be  inserted  without  rearranging  the  forms.  In  due  time, 
to  meet  the  growing  demands  of  trade,  regular  quarterly 
volumes  were  issued,  in  January,  April,  July,  and  October, 
including  all  changes  and  all  new  names,  up  to  the  approx- 
imate date  of  issue.  The  rating  books  now  list  almost 
2,000,000  names. 

Necessity  for  Credit  Investigation 

Credit  is  first  of  all  based  upon  the  personality.  A 
man's  own  character,  abilities,  and  energies  are  the  basis 


90  MERCANTILE  CREDITS 

for  credit,  just  as  they  constitute  his  powers  in  the  business 
of  life  itself.  It  has  been  well  said  that,  uthe  intercourse 
of  society — its  trade,  its  religion,  its  friendships,  its  quar- 
rels— is  one  wide  judicial  investigation  of  character."  In- 
vestigation of  some  sort  is  necessary  for  the  establish- 
ment, maintenance,  and  protection  of  all  that  pertains  to 
human  interests — whether  social,  religious,  or  mercantile. 
Just  as  society  protects  itself  by  perpetual  and  diligent 
inquiry  regarding  the  character,  habits,  and  associations 
of  its  every  member,  so  the  mercantile  world  recognizes 
the  need  of  investigation  as  to  the  character  and  responsi- 
bility of  its  membership.  And  this  function  the  mercantile 
agency  undertakes  to  discharge.  It  aims  to  be  the  clearing 
house  of  credit;  to  be  the  conserver  of  solvency  on  the 
one  hand,  and  the  active  enemy  of  the  dishonest  trader  on 
the  other. 

The  chief  advantage  realized  from  the  activity  of  the 
agency  is  that  the  information  necessary  for  accurate 
judgment  as  to  commercial  credits  is  obtained  through 
a  number  of  varied  and  trustworthy  sources — sources 
which  would  be  entirely  inaccessible  to  the  majority  of 
private  persons. 

Bases  of  Credit 

As  before  stated,  character  is  the  first  factor  to  be  con- 
sidered. Capital  is  desirable  and  even  necessary,  but 
without  a  solid  basis  of  character  laid  by  the  business  man 
himself,  capital  alone  will  not  suffice.  The  individual's 
own  statement,  properly  confirmed  by  the  mercantile 
agency,  must  form  the  ground  work  of  the  credit  report, 
and  the  value  of  this  statement  depends  largely  upon  his 
personal  character,  just  as  his  business  success  depends 
largely  upon  his  personal  ability. 


COMMERCIAL  AGENCIES  AND  REPORTS      91 

Influence  of  the  Agencies  on  Commerce 

Capital,  character  and  ability,  all  of  them  important 
requisites,  would,  however,  be  of  little  or  no  avail  without 
the  medium  of  the  credit  reporting  system,  which  affords 
to  the  outside  world  the  evidence  it  must  have  as  to  the 
actual  existence  of  these  qualifications.  Wherever  we  find 
the  credit  agency  flourishing  there  is  also  found  prosperity 
and  progress.  On  the  other  hand,  wherever  the  credit 
agency  is  unknown  or  hampered  by  ill-advised  legislation 
there  is  sure  to  be  found  an  unregulated,  feeble,  and  inter- 
mittent traffic. 

This  fact  was  well  illustrated  when  some  years  ago  a 
western  state  enacted  some  hasty  legislation  which  made 
it  practically  impossible  for  a  reporting  agency  legally  to 
conduct  its  work  in  that  state.  Bradstreet's  omitted  the 
state  from  its  rating  books,  giving  in  its  place  an  abstract 
of  the  laws  which  had  made  such  action  necessary,  and 
advising  its  patrons  that  no  reports  could  be  supplied  on 
mercantile  subjects  in  that  state.  Dealers  and  manufac- 
turers, being  thus  deprived  of  the  usual  means  of  getting 
information  as  to  the  credit  standing  of  the  merchants  of 
this  state,  greatly  curtailed  credits  in  that  section,  and  in 
some  instances  refused  the  extension  of  further  credit  al- 
together, with  the  result  that  the  legislature  was  urgently 
petitioned  to  repeal  those  particular  laws.  The  petition 
was  successful,  as  it  was  obvious  that  the  effect  of  this 
legislation  on  the  mercantile  credit  and  prosperity  of  the 
state  had  not  been  carefully  considered. 

Nature  of  the  Reports 

The  agency  report  of  today  is  a  summary  of  all  the 
facts  necessary  for  the  information  of  the  merchant,  man- 
ufacturer, or  banker  who  has  to  decide  on  the  wisdom  and 


92  MERCANTILE  CREDITS 

expediency  of  granting  credit  to  the  subject  of  the  report. 
Full  details  are  given;  but  with  conciseness,  with  simplicity 
of  language,  and  without  any  attempt  at  verbal  embellish- 
ment; and  the  report  is  such  as  can  be  readily  compre- 
hended by  any  reasonably  intelligent  business  man. 

Methods  of  Collecting  Information 

The  modus  operandi  of  the  agency  in  gathering  its 
data  and  constructing  its  report  is  about  as  follows :  The 
reporter  or  correspondent — according  as  the  report  is  in 
the  city  where  the  agency  has  an  office,  or  in  the  country — 
approaches  the  subject  for  a  statement  of  his  financial 
affairs.  It  should  be  borne  in  mind,  however,  that  the 
agency  representative  cannot  compel  the  subject  to  submit 
a  statement  if  he  does  not  see  fit  to  do  so.  On  the  other 
hand,  very  many  modern  business  men  have  been  long 
since  convinced,  by  the  agencies  and  by  their  own  necessi- 
ties, of  the  desirability  of  submitting  financial  statements; 
and  the  number  who  establish  their  credit  by  this  method 
represent  a  very  large  percentage  of  the  total  engaged  in 
business.  The  credit  man  of  today  at  once  sets  a  mark 
against  the  customer  who  declines  to  make  a  statement  to 
the  agencies.  If  a  merchant  asks  credit  he  owes  it  to  the 
grantor  of  this  credit  to  acquaint  him  with  his  ability  to 
discharge  the  obligation  at  maturity;  and  the  only  logical 
way  to  do  this  thoroughly  is  through  the  agencies,  which 
have  the  facilities  for  checking  up  the  statement  and  test- 
ing its  accuracy. 

The  merchant  is  also  asked  by  the  agency  representa- 
tive to  state  his  former  place  of  residence,  as  his  previous 
record  very  frequently  determines  the  degree  of  credence 
to  which  his  financial  statement  is  entitled.  This  antece- 
dent record  will  relate  the  experience  and  qualifications  of 
the  subject,  his  manner  of  paying  bills,  whether  or  not  he 


COMMERCIAL  AGENCIES  AND  REPORTS     93 

failed  or  left  any  unsettled  liabilities,  his  estimated  worth 
at  time  of  leaving,  etc.  Then  trade  opinions  are  secured, 
and  authorities  consulted  who  are  qualified  to  pass  upon 
such  points  as  whether  the  merchant  is  commencing  with 
reasonable  capital  for  the  venture ;  whether  there  is  a  good 
opening  at  the  time  and  location  for  the  line  engaged  in, 
etc.,  etc. 

Form  of  Report 

To  illustrate  more  clearly  the  construction  of  these 
reports,  one  of  the  simpler  forms  issued  by  Bradstreet's 
is  given  below: 

LACOMB,  F.  A.  DRY  GOODS  MODEVILLE,  PA. 

Francis  A.,  age  67,  married.  Clearfield  Co. 

March  21,  1913,  he  dictated  to  our  traveling  reporter  the  fol- 
lowing statement,  which  he  signed: 

"Financial  condition  March  21,  1913,  as  per  estimate: 

ASSETS: 

Merchandise  at  cost $  50,000 

Accounts  receivable,  actual  value 7,000 

Cash  in  bank 1,000 

Cash  on  hand 400 

Fixtures,  actual  value 5,000 

Homestead  and  other  real  estate 80,000 

Other  assets,  securities 1,000 

TOTAL  VALUE  OF  ASSETS $144,400 

LIABILITIES: 

On  open  account  for  merchandise $    6,000 

Mortgage  on  homestead  and  other  real  estate     50,000 

TOTAL  AMOUNT  OF  INDEBTEDNESS $  56,000 

Insurance  on  merchandise,  $35,000.  Buildings  are  all  insured. 
Never  suffered  a  fire  loss.  The  real  estate  given  in  this  statement 
stands  of  record  in  the  name  of  Francis  A.  Lacomb. 

(Signed)    p.  A.  LACOMB." 


94  MERCANTILE  CREDITS 

He  was  formerly  engaged  as  an  oil  producer  and  formed  a  part- 
nership with  his  son-in-law,  C.  A.  Brown,  and  they  started  in  the 
dry-goods  business  in  September,  1906,  the  firm  operating  under 
style  of  C.  A.  Brown  &  Co.  They  continued  until  May  8,  1907, 
when  the  business  was  incorporated  under  style  of  the  C.  A. 
Brown  Co. 

The  latter  corporation  was  organized  under  Pennsylvania  laws, 
with  an  authorized  capital  of  $150,000,  charter  dated  April  18,  1907, 
and  at  the  time  they  claimed  to  have  a  paid-up  capital  of  $100,000. 

The  corporation  operated  two  stores,  one  in  Modeville  and  one 
in  Frankdale,  Pa.  In  a  statement  submitted  as  of  April  23,  1909, 
the  corporation  represented  its  total  assets  at  $162,807,  with  liabili- 
ties, exclusive  of  capital  stock,  of  $62,807.  Under  Brown's  manage- 
ment, the  business  is  reported  to  have  run  steadily  behind  and  to 
have  lost  money. 

About  January  1,  1910,  F.  A.  Lacomb  took  over  the  business 
from  the  corporation,  disposed  of  the  stock  in  the  Frankdale  store 
and  has  since  continued  to  conduct  the  Modeville  store  only.  As 
one  of  the  conditions  connected  with  the  transfer  of  the  business 
to  him,  Mr.  Lacomb  is  said  to  have  assumed  the  obligations  of  the 
corporation.  In  order  to  provide  for  this  indebtedness,  authorities 
advise  us  that  he  has  arranged  with  a  local  and  out-of-town  bank 
to  furnish  funds  to  the  extent  of  about  $45,000  and  as  security  he 
has  given  a  mortgage  on  his  real  estate  for  $50,000,  as  indicated 
by  the  Crawford  County  records  of  March  9,  1910,  mortgage 
payable  six  months  after  date. 

We  are  advised  that  Mr.  Lacomb  has  been  steadily  reducing 
the  C.  A.  Brown  Co.'s  liabilities,  until  at  the  present  time  it  is 
understood  these  debts  amount  to  about  $18,000.  An  authority  who 
is  familiar  with  his  affairs  estimates  his  farm,  containing  about  685 
acres,  at  about  $55,000,  and  his  real  estate  in  Modeville  at  $15,000, 
making  the  total  estimated  value  of  the  real  estate  $70,006.  Other 
informants  who  have  known  Mr.  Lacomb  for  many  years  state  that 
he  is  a  man  of  integrity,  and  they  have  expressed  their  confidence 
in  his  ability  to  put  the  business  on  a  prosperous  basis.  The  gen- 
eral opinion  among  those  consulted  is  that  his  net  worth  may  be 
conservatively  estimated  as  between  $35,000  and  $50,000  after  making 
all  reasonable  allowances. 

TRADE  OPINIONS:  May,  1913.  In  an  out-of-town  market  two 
authorities  have  been  found  who  have  credited  the  concern  up  to 
$1,000  each  on  seventy  days,  and  payments  have  been  prompt.  A 
third  house  has  credited  as  high  as  $2,000  and  payments  have  been 
lately  prompt,  but  previously  slow.  A  fourth  authority  has  credited 
to  the  extent  of  $500,  last  transaction  two  weeks  ago,  and  pay- 


COMMERCIAL  AGENCIES   AND  REPORTS      95 

ments,  at  one  time  30  days  slow,  have  improved  to  prompt  or  only 
a  few  days  slow.  Three  other  dealers  have  credited  in  amounts  of 
$75,  $400,  and  $1,200  respectively,  on  60  days,  and  payments  to  all 
have  been  prompt,  nothing  owing  which  is  past  due.  At  four  other 
sources  the  account  has  been  checked  for  $300  at  one  source,  $700 
at  another,  $1,000  at  a  third,  and  $1,500  at  a  fourth,  and  payments 
have  been  made  either  according  to  terms  or  fairly  promptly. 

R  C May  5,  1913. 

Of  course,  there  are  reports  of  much  more  elaborate 
and  extended  character  on  large  wholesale  houses,  bank- 
ers, manufacturers,  and  industrial  combinations,  which 
contain  exhaustive,  analytical  statements  furnished  by  the 
concerns  themselves,  with  appropriate  comments  on  their 
prospects,  degree  of  prosperity,  character,  and  methods 
of  management,  and  observance  of  their  obligations,  the 
whole  forming  a  general  summary  of  all  the  facts  con- 
stituting their  standing  in  the  mercantile  world. 

Necessity  for  Cooperation 

The  reader  has  doubtless  met  credit  men  who  have 
professed  to  see  little  good  in  mercantile  agencies  and 
their  reports,  while  others,  and  these  usually  the  most  suc- 
cessful, say  they  would  not  know  how  to  get  along  with- 
out them.  Here  we  touch  upon  a  very  important  point, 
because  the  results  the  credit  man  derives  from  agency 
service  are  largely  dependent  upon  his  attitude  toward  the 
agencies.  If  he  recognizes  that  the  agency  is  in  reality  but 
a  branch  of  the  credit  department,  and  the  workers  therein 
but  his  colleagues,  and  gives  them  the  keenest  coopera- 
tion, confidence,  patience,  and  good  fellowship,  the  results 
to  him  will  be  rarely  disappointing  and  the  highest  mutual 
success  will  generally  be  attained.  Now,  this  is  invariably 
the  attitude  of  the  credit  man  who  says  he  could  not  get 
along  without  the  agency.  The  largest  firms  and  most 
successful  houses  with  which  I  am  familiar  are  liberal 


96  MERCANTILE  CREDITS 

users  of  agency  service  and  reports,  never  curtailing  their 
credit  men  in  this  respect.  They  regard  the  disbursement 
for  agency  service  as  nominal  when  they  consider  the 
volume  of  credit  business  they  transact  each  year,  and 
which  the  agency  service  aids  them  to  protect.  They 
realize  that  they  cannot  have  at  hand  too  much  informa- 
tion on  the  people  to  whom  they  are  selling;  they  see  the 
importance  of  being  entirely  familiar  with  the  business  of 
their  customers  and  the  various  conditions  surrounding 
them ;  they  understand  that  it  is  not  only  a  question  of  ex- 
tending or  not  extending  credit,  but  also  one  of  how  much. 

Accuracy  of  Information 

The  credit  man's  constant  cooperation  with  the  agency 
is  of  very  great  importance.  If  every  credit  man  were  to 
educate  the  salesman  to  state  on  the  order  blank  in  every 
case  the  proper  official  style  of  the  firm  on  which  informa- 
tion is  desired,  correctly  spelt,  instead  of  some  nominal 
trade  or  awning  style  which  may  have  been  used  by  dif- 
ferent owners  of  the  business  for  as  much  as  ten  years 
past,  this  one  improvement  alone  would  vastly  increase  the 
promptness  of  agency  service;  as  much  wasted  time  and 
effort  would  then  be  avoided,  which  could  be  used  to  ad- 
vantage elsewhere  on  the  subscriber's  behalf. 

Of  equal  importance  is  the  street  address  of  the  cus- 
tomer in  the  larger  towns,  which  salesmen  should  always 
be  required  to  furnish.  Lack  of  proper  firm  name  and 
street  address  on  the  inquiry  blank  which  the  agency  sends 
to  its  correspondents,  especially  in  the  larger  towns,  causes 
more  good  correspondents  to  resign  their  posts  than  any 
other  known  cause.  The  character  of  agency  work  re- 
quires a  responsible,  intelligent,  representative  man;  and 
the  services  of  such  a  man  cannot  be  retained  if  he  receives 
many  inquiries  which,  in  consequence  of  a  defect  in  the 


COMMERCIAL  AGENCIES  AND  REPORTS     97 

firm  style  or  street  address  (the  last  particular  is  some- 
times entirely  missing),  make  it  necessary  for  him  to  go 
through  the  town  with  a  fine  tooth  comb  in  order  to  locate 
the  subject  of  inquiry.  He  cannot  afford  to  waste  his  time 
this  way,  and  soon  resigns.  This  is  a  considerable  detri- 
ment not  only  to  the  agency  itself,  but  to  the  subscriber,  as 
good  correspondents  are  not  so  plentiful  and  so  readily 
engaged  as  might  be  supposed. 

Completeness  of  Information 

Moreover,  if  every  credit  man  would  fill  in  as  far  as 
possible  answers  to  all  the  questions  on  the  back  of  the 
inquiry  ticket,  it  would  further  the  efforts  of  the  agency 
to  supply  quick  as  well  as  accurate  service.  It  is  absolutely 
essential  that  the  agency  and  the  credit  man  work  together 
if  prompt  service  is  to  follow,  and  yet  I  have  known  some 
instances  where  subscribers  have  withheld  information 
when  putting  in  an  inquiry,  which,  if  given  to  the  agency  at 
first  as  a  clue  or  lead,  would  have  saved  much  valuable 
time.  However,  it  is  only  fair  to  state  that  most  modern 
credit  men  are  trying  to  help  the  agency  and  incidentally 
themselves  in  every  way,  though  many  of  them  lament 
the  difficulty  of  educating  the  sales  force  to  the  importance 
of  the  details  mentioned. 

Insufficiency  of  Private  Investigation 

The  reason  why  each  credit  department  does  not,  as 
you  might  say,  act  as  its  own  mercantile  agency,  is  because 
it  lacks  the  necessary  facilities.  Hence,  the  mercantile 
agency  steps  in  and  acts  as  agent  for  all  dispensers  of 
credit  the  country  over,  devoting  all  of  its  time  and  energy 
to  this  one  feature  of  modern  business.  With  its  vast  or- 
ganization over  the  whole  world,  its  many  offices,  its  rec- 


98  MERCANTILE  CREDITS 

ords,  and  its  experience,  it  is  able  to  gather  and  issue  to 
its  subscribers  dependable  reports  at  a  nominal  fee  com- 
pared with  what  it  would  cost  each  credit  department  to 
secure  these  data  itself.  As  a  matter  of  fact,  there  are 
probably  some  portions  of  the  antecedent  record  of  the 
subject  which  neither  the  credit  department  nor  any  affili- 
ated credit  bureaus  could  possibly  secure. 

As  an  illustration,  let  us  say  that  John  Smith  is  a  new- 
comer to  a  community;  commences  business  forthwith,  and 
says  he  came  from  some  little  hamlet  in  Alaska,  or  Hono- 
lulu, or  Australia,  or  any  other  remote  point  on  the  globe. 
Could  the  credit  department  obtain  this  man's  antecedent 
record?  No;  but  the  office  of  the  agency  reporting  the 
previous  place  of  residence  of  John  Smith  will  have  on 
file  his  business  history,  which  will  reflect  his  reputation, 
his  manner  of  paying  bills,  court  records  covering  such 
things  as  judgments  for  debts  and  petitions  in  bankruptcy, 
if  any,  and  finally  his  reported  financial  worth  at  time  of 
leaving. 

Importance  of  Antecedent  Record 

This  antecedent  record  is  often  more  important  than 
any  other  feature  of  the  report,  especially  if  it  indicates 
traces  of  dishonesty,  for  it  may  be  presumed  that  a  man's 
antecedents  will  exercise  some  influence  on  his  future  rec- 
ord. The  mercantile  agency  records  bear  this  out.  It  is 
nearly  always  the  case  that  the  merchant  who  has  been  in 
business  for  a  term  of  years  and  has  maintained  an  honor- 
able position  as  to  his  dealings  and  the  discharge  of  his 
obligations  (this,  by  the  way,  does  not  necessarily  imply 
invariable  promptness),  sustains  this  favorable  record  to 
the  end  of  the  chapter,  no  matter  where  he  may  go.  It 
is  always  safe  to  extend  reasonable  credit  to  a  man  of  this 
kind  almost  regardless  of  his  capital,  because  he  will  be  a. 


COMMERCIAL  AGENCIES  AND  REPORTS     99 

careful  buyer,  not  likely  to  contract  beyond  his  ability  to 
pay,  and  will  in  all  probability  eventually  bring  his  newest 
business  to  a  successful  issue,  as  in  the  past.  The  excep- 
tions to  this  general  rule  are  so  rare  that  they  simply  help 
to  prove  it.  And  if  a  man  with  a  good  record  wanders 
from  the  straight  and  narrow  path  and  causes  a  money 
loss  to  his  creditor's  firm,  the  credit  man  is  in  no  measure 
to  blame,  nor  is  the  mercantile  agency,  for  neither  can  look 
down  into  a  man's  heart  and  foretell  what  he  is  going 
to  do.  If  he  has  previously  been  recognized  as  a  reputable 
man,  we  are  justified  in  assuming  that  he  will  continue  to 
deal  honorably;  and  the  agency  records  show  that  in  the 
very  large  majority  of  cases  this  judgment  will  be  correct. 
This  works  both  ways,  however;  so  it  is  well  to  remember 
that  usually,  where  antecedent  investigation  shows  a  man's 
record  to  have  been  bad  in  matter  of  principle,  he  should 
be  closely  watched,  and  transactions  with  him  well 
guarded,  for  this  kind  of  man  will  generally  repeat  his 
previous  record.  It  will  be  seen  from  this  how  important 
a  factor  is  the  antecedent  information  embraced  in  mer- 
cantile agency  reports.  Indeed,  many  credit  men,  to  save 
time,  endeavor  to  learn  from  the  customer  starting  a  new 
business,  where  he  was  formerly  located,  and  convey  this 
information  to  the  agency  when  putting  in  their  inquiry. 
This  enables  the  agency  to  start  a  request  for  the  man's 
antecedent  record  by  first  mail,  in  the  meantime  proceed- 
ing in  the  usual  way  to  interview  the  man  and  secure  his 
financial  statement. 

Accuracy  of  Agency  Reports 

It  may  be  said  at  this  point  that  failure  statistics  give 
encouraging  corroboration  of  the  substantial  accuracy  of 
the  agency  reports.  For  instance,  the  following  statistics 
prepared  by  Bradstreet's  show  that  there  were  some  14,- 


ioo  MERCANTILE  CREDITS 

047  failures  during  1911  in  the  United  States  and  Canada, 
and  of  this  number  13,187  (or  93  per  cent)  had  very  nom- 
inal or  no  credit  ratings;  only  766  of  those  who  failed 
were  rated  in  good  credit,  and  only  94  in  very  good  or 
highest  credit. 

It  has  also  been  deduced  from  the  same  statistics  that 
almost  80  per  cent  of  failures  can  be  traced  to  the  short- 
comings of  the  merchant  himself.  The  most  frequent 
cause  of  failure  is  lack  of  capital — in  other  words,  lack  of 
judgment  shown  in  commencing  business  without  sufficient 
backing;  and  next  in  line  is  incompetence,  which  includes 
poor  judgment  in  buying  merchandise  or  in  extending 
credit,  or  in  operating  expenses,  in  pricing  goods,  figuring 
costs,  etc.  Inexperience  and  extravagance,  both  business 
and  personal,  also  produce  failures.  All  these  main  points 
the  modern  credit  man  has  so  well  in  mind  that  they  almost 
automatically  come  up  for  consideration  when  deter- 
mining credit  or  investigating  an  account. 

The  Agency  Cannot  be  Infallible 

It  is  the  constant  effort  of  the  old-established  agencies 
to  provide  the  credit  man  with  the  most  thorough  and  re- 
liable reports  humanly  possible  to  secure.  I  say  humanly 
possible  because  the  agencies  are  not  infallible,  nor  can 
they  ever  attain  absolute  perfection  in  their  reports  or 
ratings,  for  they  have  to  depend  upon  human  effort — that 
is,  the  efforts  of  their  thousands  of  correspondents  in  the 
towns  and  villages  throughout  the  land.  The  most  the 
credit  man  can  demand  of  the  agency  is  unquestionable 
good  faith,  and  a  system  carefully  calculated  to  bring  the 
service  up  to  as  high  a  standard  of  efficiency  as  possible. 
If  the  agency  reports  were  infallible,  there  would  be  no 
need  of  credit  men,  for  then  the  agency  could  automati- 
cally take  their  places.  But  since  the  reports  are  not  and 


COMMERCIAL  AGENCIES  AND  REPORTS    101 

cannot  be  absolutely  free  from  faults,  they  should  be  taken 
together  with  other  facts  of  which  the  subscriber  or  credit 
man  may  have  personal  knowledge. 

Rates  of  the  Agencies 

During  recent  years  the  credit  man  has  been  asking 
more  and  more  of  the  agencies;  and  willing  response  has 
been  made  to  these  demands,  at  least  to  such  as  were 
feasible.  But  these  demands  on  the  part  of  the  credit 
man  call  for  something  in  return  on  his  part;  namely,  co- 
operation, as  already  explained,  and  in  addition,  a  readi- 
ness to  pay  a  proper  fee  for  the  service.  The  agency 
report  of  today  bears  but  scant  resemblance  to  the  report 
of  a  decade  or  more  ago,  and  is  vastly  more  costly  to 
procure;  but  the  advance  in  the  agency  rates  have  been 
very  inconsiderable.  Personally,  the  writer  feels  that 
agency  rates  have  always  been  too  low.  A  disbursement 
of  a  hundred  dollars  or  so  a  year  for  credit  information 
by  a  firm  which  transacts  annually  a  credit  business 
ranging  all  the  way  from  $100,000  up  to  several 
millions,  is  surely  not  exorbitant.  Very  often  the  sub- 
scription price  for  a  dozen  years  may  be  involved  in  any 
one  account  or  bill,  and  yet  the  service  covers  the  credit 
accounts  for  the  entire  year.  It  would  be  well  if  sub- 
scribers could  have  a  more  direct  and  extensive  knowledge 
of  the  difficulties  the  agencies  daily  meet  with,  in  gathering 
their  data.  They  would  then  be  a  little  more  indulgent 
and  cooperative. 


CHAPTER  VI 
CREDITS   AND   COLLECTIONS 

BY  C.  A.  PARMELEE 

The  Development  of  Business  Science 

Most  of  the  risks  or  hazards  of  commerce  have  been 
gradually  eliminated,  and  modern  insurance  methods  have 
made  it  possible  to  protect  the  merchant  on  sea  and  land. 
Improved  means  of  transportation  and  quick  communica- 
tion have  resulted  in  greater  stability  of  prices ;  but,  until 
within  the  past  twenty  years,  business  has  never  been  re- 
duced to  a  science,  and  the  greatest  advancement  has  been 
made  within  the  last  decade. 

A  few  years  ago,  the  majority  of  merchants  were  still 
working  in  a  more  or  less  haphazard  manner.  They 
bought  as  best  they  could,  sold  in  like  manner,  established 
a  profit  rate  they  thought  necessary  or  that  competition 
would  warrant,  and  did  the  best  they  could  with  expenses. 
Having  done  this,  they  trusted  to  luck  and  waited  until  the 
end  of  the  year  for  the  inventory  to  show  what  had  been 
accomplished. 

But  under  present  methods  of  systematizing,  account- 
ing, and  the  segregation  of  various  items  of  profit  and 
expense,  it  has  become  possible  for  the  merchant  to  know 
absolutely,  monthly,  weekly,  or  even  daily,  his  exact  finan- 
cial condition — how  much  he  has  made  or  lost  in  each  de- 
partment. Almost  automatically  a  way  is  opened  to 
remedy  a  weakness,  stop  a  leak  or  increase  a  net  profit. 

1 02 


CREDITS  AND  COLLECTIONS  103 

Importance  of  the  Credit  Department 

Credit  is  one  of  the  principal  links  in  the  great  chain 
upon  which  modern  business  hangs,  and  the  most  im- 
portant and  final  accomplishment  of  the  credit  department 
is  collecting  the  money.  Credits  and  collections  are  just 
as  important  to  a  successful  business  as  buying  and  sell- 
ing. The  tens  of  thousands  of  great  fortunes  that  have 
been  built  up  by  commerce  and  trade  had  their  origin,  in 
almost  every  case,  in  a  business  conducted  on  a  credit 
basis. 

There  are,  of  course,  a  few  very  marked  exceptions; 
but  they  are  almost  entirely  among  retailers,  such  as  the 
Woolworth  Syndicate  and  many  of  our  department  stores, 
which  are  operated  on  a  strictly  cash  basis  in  selling,  but 
buy  on  credit,  usually  taking  advantage  of  all  cash 
discounts. 

Credit  Risks 

The  conduct  of  a  mercantile  business  on  a  credit  basis 
is  not,  or  at  least  need  not  be,  a  hazardous  undertaking. 
There  will  always  be  some  loss  from  bad  accounts  in  any 
credit  business,  large  or  small,  but  given  proper  organiza- 
tion and  management,  the  rate  of  loss  will  be  a  mere  frac- 
tion of  a  per  cent.  And  furthermore,  the  probable  loss 
can  be  forecast  almost  as  accurately  as  the  death  rate  can 
be  figured  from  the  actuary  tables  of  our  life  insurance 
companies — and  that  is  so  accurate  as  to  warrant  the 
investment  of  hundreds  of  millions  of  dollars.  The  rate 
of  loss  from  bad  accounts  can  be  so  closely  estimated  that 
there  are  credit  insurance  companies  which,  for  a  com- 
paratively small  premium,  will  guarantee  against  any  loss 
in  excess  of  the  normal  rate.  In  speaking  of  the  normal 
rate  of  loss  I  refer  to  the  average  rate  which,  as  time  and 
experience  have  shown,  exists  in  various  lines. 


104  MERCANTILE  CREDITS 

Duties  of  the  Credit  Man 

Right  here,  however,  is  where  the  fine  work  of  the 
credit  man  comes  in.  He  must  work  with  the  sales 
department,  to  build  up  sales  and  develop  trade,  and  must 
not  drive  it  away  by  drastic  collection  methods  or  undue 
caution;  and  yet  he  must  be  so  able  and  so  well  informed 
that  he  will  not  lose  an  account  or  let  it  run  so  long  that 
it  becomes  unprofitable.  It  is  easy  to  reduce  the  losses 
if  you  ignore  the  necessity  for  business  development. 

It  is  the  duty  of  the  credit  department  to  act  as  a 
guardian  over  the  many  customers  throughout  the  country. 
They  should  not  be  permitted  to  overbuy,  and  so  contract 
obligations  beyond  their  financial  strength.  If  credit  is 
easily  obtained,  and  they  do  not  feel  the  serious  obliga- 
tion of  paying  accounts  when  due,  there  is,  in  nearly  all 
cases,  a  tendency  to  overbuy  and  thus  accumulate  dead 
stock,  and  this  results  in  loss  of  profits,  a  generally  un- 
satisfactory condition  of  business,  and  too  often  in  final 
failure. 

The  credit  man  should  also  insist  that  the  stock  of 
merchandise  of  all  debtors  be  adequately  insured.  This 
is  a  necessary  protection  for  all  parties;  and  a  business 
that  cannot  afford  to  pay  the  premium  on  a  fire  insurance 
policy  should  not  be  allowed  to  continue. 

The  custom  of  charging  interest  on  overdue  accounts 
is  becoming  quite  general,  is  entirely  just  and  to  be 
encouraged. 

Duties'of  the  Collection  Department 

The  art  of  collecting  can  be  successfully  practiced  only 
by  those  who  have  patience,  good  judgment,  courage,  and 
decision  to  act  quickly  in  emergencies,  and  a  willingness  to 
use  harsh  methods  when  conditions  demand  it. 

It  is  the  first  duty  of  the  collection  department  to  col- 


CREDITS  AND  COLLECTIONS  105 

lect  accounts  when  due.  It  will  be  found  that  a  fairly 
large  percentage  of  debtors  pay  promptly  and  therefore 
require  little  attention;  the  remainder  come  under  the 
various  headings  of  slow,  very  slow,  undesirable,  and 
bad,  and  must  be  watched. 

All  accounts  should  be  watched  at  all  times,  but 
especially  the  slow  accounts.  When  the  reason  for  slow 
payment  is  discovered,  the  remedy  can  usually  be  found. 
It  is  very  necessary  to  keep  in  close  touch  with  debtors; 
and  a  personal  visit  of  the  credit  man  to  the  debtor,  as 
often  as  once  a  year,  is  very  desirable.  This  gives  an 
opportunity  to  size  up  not  only  the  man,  but  also  his 
business,  his  methods,  and  the  condition  of  his  stock.  Then 
again,  a  man  is  sometimes  A-i  this  year,  but  by  next  year 
is  on  the  down  grade,  and  the  account  may,  in  a  short  time, 
change  from  good  to  bad. 

Watching  an  Account 

I  recall  an  instance  of  a  jeweler  in  one  of  our  nearby 
cities,  who  had  been  an  excellent  customer  for  a  number  of 
years.  He  did  a  good  business,  and  his  account  was  very 
desirable.  After  a  while,  however,  we  noticed  that  he 
was  getting  a  little  behind.  When  he  was  reminded  of 
his  past-due  account  he  replied  giving  a  very  plausible 
excuse,  and  asked  for  a  considerable  extension  on  most  of 
the  indebtedness.  Owing  to  his  previous  record  this  was 
granted.  A  few  months  later  he  did  not  reply  to  corre- 
spondence, and  investigation  disclosed  that  he  was  drink- 
ing to  excess,  and  gambling;  but  all  this  had  been  carried 
on  so  quietly  that  our  regular  salesman  had  not  learned 
the  facts.  I  then  made  a  personal  call,  and  spent  the 
entire  day  with  this  man  getting  information.  Conditions 
were  so  bad  that  his  continued  patronage  was  not  wanted, 
and  I  was  free  to  use  harsh  methods  so  far  as  necessary. 


io6  MERCANTILE  CREDITS 

As  a  result,  $500  was  raised  that  day,  some  merchandise 
was  returned,  and  a  fairly  satisfactory  adjustment  effected. 
Within  60  days  he  was  forced  to  make  an  assignment, 
with  assets  of  $2,500  and  liabilities  of  $6,000.  This  is 
an  example  of  how  quickly  a  good  account  can,  under 
adverse  circumstances,  become  a  bad  one. 

It  is  equally  important  to  watch  weak  or  even  bad 
accounts,  for  in  this  day  of  speculation  and  quick  profits 
many  a  poor  risk  has  suddenly  become  a  desirable  and 
profitable  account.  I  have  in  mind  a  man  in  this  city  who 
today  is  worth  undoubtedly  $20,000,000,  whom  our  firm 
only  a  few  years  ago,  and  for  good  reasons,  held  strictly 
to  C.  O.  D.  He  was  broad-minded  enough,  however, 
not  to  hold  a  grudge,  and  when  he  had  money  became  a 
liberal  buyer,  running  an  account. 

System  in  the  Collection  Department 

On  the  subject  of  system  in  the  collection  department, 
I  cannot  do  better  than  quote  the  following  article* : 

"PLAN  YOUR  WORK— THEN  WORK  YOUR  PLAN." 

uThe  best  results  in  collection  come  from  working  on 
a  systematic  plan,  which  begins  with  a  request  for  pay- 
ment when  an  account  becomes  due  and  ends  only  when  the 
money  is  collected,  hammering  away  at  regular  intervals 
with  form  letters  when  they  can  be  used  effectively,  but 
discriminating  carefully  in  their  use,  and  changing  the 
forms  frequently. 

"Work  on  collections  begins  with  the  monthly  state- 
ments. All  statements  should  be  out  not  later  than  the 
5th  of  each  month;  and,  if  it  is  possible,  have  them  out  on 


*By  R.  W.  Van  Valkenburgh,  of  the  Western  Electric  Company  of  New  York. 


CREDITS  AND  COLLECTIONS  107 

the  3rd.    When  you  get  statements  from  the  bookkeeper 
divide  them  into  three  classes : 

ist.     Those    having    items    dated    only    during    the 

previous  month. 
2nd.  Those  having  items  dated  in  the  second 

previous  month. 
3rd.  Those  having  items  in  the  third  previous  month 

or  prior. 

"The  first  class  may  go  without  comment,  as  they  are 
not  due  and  will  not  be  due  this  month.  The  second  class 
should  be  copied,  name,  address,  and  amount,  then  sent 
out  marked:  'Please  remit.'  The  copy  will  be  kept  until 
the  2Oth,  when  you  will  write  a  form  letter  to  those  who 
have  not  paid.  The  third  class  you  will  associate  with 
correspondence,  either  writing  a  letter  to  be  sent  with 
the  statement,  or  noting  the  amount  on  correspondence 
and  sending  statement  out  without  comment.  During  the 
last  few  days  in  the  month,  it  is  a  good  plan  to  write  to 
nearly  all  of  your  overdue  accounts;  then  when  the  state- 
ment comes  through  you  can  rush  it  out  without  a  letter, 
and  it  will  act  on  the  customer  as  a  reminder  of  the  letter 
received  a  few  days  before. 

"Do  not  get  into  the  habit  of  just  asking  for  money — 
call  attention  to  indebtedness,  first  in  a  form  letter,  after 
that  write  such  a  letter  as  will  appeal  to  the  man  you  are 
writing  to.  In  order  to  do  this  you  must  know  your  man. 
There  is  a  considerable  percentage  of  your  customers  to 
whom  form  letters  should  not  be  sent,  and  there  is  some 
question  of  their  value  after  the  first  letter.  I  prefer  to 
study  each  account,  and  write  the  letter  that  I  think  will 
bring  the  best  result  from  the  particular  customer  in  hand, 
using  model  letters  instead  of  form  letters.  By  model 
letters,  I  mean  letters  that  have  been  well  thought  out, 


io8  MERCANTILE  CREDITS 

and  from  which  I  can  extract  a  well-turned  phrase  to  meet 
the  case  in  hand.  Certainly  it  is  a  mistake  to  let  a  cus- 
tomer know  you  are  writing  him  form  letters. 

uThe  second  letter  I  have  usually  made  to  express 
my  disappointment  or  surprise  at  not  having  received  the 
remittance  asked  for  in  the  previous  letter,  taking  at  all 
times  the  stand,  in  a  firm,  courteous  manner,  that,  as  the 
amount  is  due,  I  am  entitled  to  a  remittance  or  an  ex- 
planation. 

"The  third  letter  might  call  attention  to  the  previous 
two,  and  notify  that  draft  is  being  made  through  the  bank 
with  whom  the  customer  does  business.  To  provide  this 
information,  names  of  banks  used  by  customers  should  be 
taken  from  incoming  remittances  and  noted  on  the  ledger. 

"It  is  not  worth  while  to  apologize  to  your  customers 
when  you  want  them  to  pay  up — for  instance,  asking  them 
to  pay  because  'we  are  in  need  of  funds/  or  'have  large 
obligations  to  meet.'  You  really  want  them  to  pay  be- 
cause the  money  is  due;  and  if  for  any  good  reason  they 
cannot  pay,  you  should  usually  be  willing  to  extend  more 
time;  but  you  are  entitled  to  a  reason;  and  most  men  will 
think  more  of  you  for  saying  what  must  be  said  in  a 
straightforward  business-like  way,  appealing,  whenever 
possible,  through  your  personal  knowledge  of  them.  In 
this  connection  let  me  say  that  it  is  just  about  as  im- 
portant for  the  credit  man  to  know  the  customer  person- 
ally, as  it  is  for  the  salesman  to  know  him.  There  are  a 
good  many  customers  in  every  territory  whose  accounts 
will  be  made  larger  when  the  credit  man  can  see  and  talk 
with  them. 

"Insist  that  the  books  be  kept  posted  up  to  date.  You 
cannot  pass  credits  nor  make  collections  intelligently  un- 
less you  know  how  your  accounts  stand.  If  you  cannot  get 
action  from  other  employees,  go  to  your  manager  without 


CREDITS  AND  COLLECTIONS  109 

hesitation  and  without  delay;  a  man  responsible  for  credits 
cannot  afford  to  take  chances  on  some  one  else's  poor 
work. 

"Keep  after  the  claim  department  all  the  time  in  the 
effort  to  keep  accounts  clean. 

"Labor  diligently  to  gain  the  confidence  of  salesmen, 
but  do  not  stand  for  any  sales  work  that  interferes  with 
collecting  on  regular  terms,  except  with  the  knowledge  of 
the  manager.  If  anyone  gets  better  than  regular  terms 
you  must  be  consulted,  and  it  is  your  duty  to  pass  on  them. 
Do  not  allow  salesmen  to  make  note  settlements  without 
consulting  you.  Advise  freely  and  often  with  the  salesmen 
regarding  their  customers,  and  be  liberal  in  extending 
credit,  but  make  the  distinction  between  liberality  and 
recklessness ;  and  when  a  customer  whose  account  amounts 
to  $500  or  more,  ignores  your  correspondence,  or  you 
have  reason  to  believe  he  is  in  trouble,  it  is  time  for  you  to 
get  out  and  see  him.  You  will  at  least  impress  him  with 
the  feeling  that  you  not  only  want,  but  expect,  fair  treat- 
ment, and  you  consider  it  only  fair  that  he  answer  your 
letters.  At  the  same  time,  if  a  credit  man  approaches  the 
average  country  merchant  in  the  right  spirit,  he  can  do  a 
lot  toward  cementing  the  customer's  friendship  to  the 
house. 

"You  should  rarely  lose  a  large  account,  because  you 
should  be  watching  them  so  closely  and  know  them  so 
well,  that  if  there  is  danger  you  are  the  first  to  know  it 
and  therefore  first  on  the  ground.  'First  come,  first 
served.'  Do  not  force  anyone  except  as  a  last  resort; 
and  on  an  account  of  any  considerable  size,  see  the  man 
before  giving  it  to  an  attorney.  You  can  almost  always 
effect  some  kind  of  a  settlement  by  getting  in  personal 
touch  with  the  customer,  and  you  do  not  antagonize  him 
as  you  do  when  an  attorney  is  called  in.  Try  to  look  at 


no  MERCANTILE  CREDITS 

each  problem  as  it  comes  up,  in  a  big,  broad-minded  way. 
Be  liberal,  honest,  and  fair;  make  that  your  attitude,  and 
you  cannot  help  but  be  right  a  good  part  of  the  time." 

Legal  Methods  of  Collection 

The  credit  man  should  have  a  fair  amount  of  legal 
knowledge,  so  as  not  to  be  entirely  dependent  upon  the 
services  of  an  attorney.  Such  knowledge,  and  judgment  as 
to  just  how  and  when  to  act,  has  saved  many  an  account, 
especially  in  cases  of  attempted  fraud. 

It  is  often  advisable  to  bring  suit  and  get  judgment 
even  though  there  is,  for  the  moment,  no  chance  of  mak- 
ing collection.  If  the  debtor  has  nothing  and  is  unable  to 
pay,  get  a  note  if  you  can  do  no  better.  If  this  is  refused, 
and  the  debtor  is  not  an  old  man,  it  will  usually  pay  to 
bring  suit  and  get  judgment.  The  judgment  can  easily 
be  kept  alive  for  an  indefinite  number  of  years,  and  it  is 
very  probable  that  sooner  or  later  the  debtor  will  acquire 
property,  and  the  account  can  be  collected.  The  law 
allows  interest  on  judgments  until  paid. 

I  recall  an  instance  in  which  an  account  of  this  kind 
was  assigned  to  the  local  board  of  trade.  They  secured 
judgment  and  kept  it  alive;  and  many  years  after  we  had 
written  the  account  off  to  profit  and  loss,  and  forgotten  it, 
they  found  the  debtor  possessed  of  real  estate  and  col- 
lected the  entire  amount  with  interest.  On  another  oc- 
casion a  hotel  man  deliberately  planned  to  beat  us  out  of 
his  account  by  transferring  his  property  to  another  per- 
son. Later  on,  one  of  our  collectors  chanced  to  overhear 
a  remark,  made  by  him  in  a  public  place,  to  the  effect  that 
he  had  a  certain  sum  of  money  on  deposit  in  one  of  the 
city  banks.  We  acted  upon  this  information,  brought  suit, 
and  attached  his  bank  account;  but  through  some  techni- 
cality he  kept  the  money  from  us.  We  nevertheless  se- 


CREDITS  AND  COLLECTIONS  in 

cured  a  judgment,  which  we  kept  alive  for  years;  and 
finally  he  found  it  so  difficult  operating  in  his  wife's  name, 
that  he  voluntarily  came  forward  and  paid  up. 

Another  debtor,  in  order  to  swindle  his  creditors, 
placed  his  property,  worth  about  $25,000,  in  his  wife's 
name.  We  with  others  brought  suit,  got  judgment,  and 
quietly  waited.  Later  on,  the  man  and  his  wife  separated ; 
and  the  husband  brought  suit  against  his  wife  for  the 
property,  stating  in  court  that  it  was  his.  This,  of  course, 
was  our  opportunity. 

Collecting  by  Instalments 

Excellent  results  are  often  obtained  on  slow  or  even 
bad  accounts,  by  arranging  for  small  and  frequent  pay- 
ments. Many  a  debtor  cannot  get  together  $50  or  $100 
at  a  time,  but  can  raise  a  smaller  amount,  and  by  getting 
this  down  to  a  weekly  basis,  great  progress  can  be  made 
in  a  few  months. 

Often  a  debtor  will  consider  a  note  more  binding  than 
an  open  account,  or  will  make  more  effort  to  meet  it  when 
due. 

The  following  form  of  instalment  note  is  legal,  and 
leaves  the  account  in  such  shape  that  any  default  of  a 
small  payment  makes  the  entire  amount  due  and  payable : 

$1096.03 

Los  Angeles,  Cal.,  Jan.  27,  1913. 

For  value  received,  we  promise  to  pay  to  the  order  of  Blank 
Company  the  sum  of  One  Thousand  Ninety-Six  and  03/100  Dollars, 
payable  in  instalments  as  follows: 

On  February  5th,  1913 $  366.03 

"    March  5th,  1913 365.00 

"   April  5th,  1913 365.00 


Total $1096.03 


H2  MERCANTILE  CREDITS 

Each  instalment  to  bear  interest  at  the  rate  of  six  per  cent  (6%) 
per  annum  from  date  hereof  until  paid.  Should  default  be  made 
in  the  payment  of  any  one  of  the  said  instalments,  or  of  any  part 
thereof,  or  of  the  interest  thereon,  upon  the  day  whereupon  the 
same  becomes  due,  then,  and  in  any  one  of  the  aforesaid  contin- 
gencies, the  whole  of  the  aforesaid  principal  sum,  or  any  balance 
unpaid  thereof,  together  with  interest  thereon,  shall  immediately 
become  due  and  payable.  The  note  shall  be  payable  at  the  Bank 
of ,  San  Francisco,  California. 


Troublesome  Retail  Accounts 

In  the  retail  business  there  are  many  excellent  ac- 
counts with  rich  patrons,  which  are  very  difficult  to  handle. 
It  is  not  uncommon  for  a  very  wealthy  woman  to  make 
frequent  and  large  purchases,  and  expect  the  account  to 
run  indefinitely,  sometimes  for  months  or  a  year.  If  an 
attempt  is  made  to  hurry  the  collection,  it  is  resented,  and 
the  account  taken  elsewhere.  This  state  of  affairs  is  ex- 
ceedingly unfortunate,  and  the  merchants  who  have  al- 
lowed such  conditions  to  grow  and  thrive  are  decidedly 
to  blame.  The  conditions  are,  however,  very  difficult  to 
correct,  as  no  united  action  can  be  secured  among  retailers 
because  of  their  fear  of  losing  good  customers. 

The  Wealthy  Customer 

I  recall  an  instance  of  a  millionaire  customer,  who 
had  traded  with  us  for  years.  She  had  been  allowing  her 
account  to  run  until  it  was  hardly  profitable  to  carry  it. 
The  credit  department  then  commenced  to  write  collection 
letters,  which  at  first  had  no  effect;  but  after  sending  the 
second  or  third,  a  check  in  full  payment  was  received,  to- 
gether with  a  very  indignant  letter.  Our  customer  de- 
clared that  she  had  traded  with  the  house  for  over  twenty 
years,  but  that  if  this  was  to  be  our  attitude  she  wanted 
the  account  closed,  as  she  had  no  time  to  check  up  and 


CREDITS  AND  COLLECTIONS 

attend  to  these  bills,  and  would  not  trade  with  a  house 
that  was  not  willing  to  allow  her  to  pay  at  her  pleasure. 

The  usual  conciliatory  letter  that  is  necessary  under 
such  circumstances  was  sent  her  in  reply.  An  occasion 
like  this  always  gives  a  good  opportunity  for  a  rather 
lengthy  letter  going  into  details,  which  can  often,  without 
giving  offense,  make  quite  clear  the  position  in  which  the 
firm  is  placed,  while  at  the  same  time  it  shows  a  willing- 
ness to  co-operate  with  the  customer  so  as  to  make  the 
continued  carrying  of  an  open  account  mutually  agreeable. 

In  the  instance  referred  to,  the  lady  continued  to  be  a 
regular  customer.  I  have  noticed  that  her  account  has 
never  since  run  over  30  or  60  days,  although  several  years 
have  now  elapsed.  I  maintain  that  all  accounts  not  paid 
within  a  reasonable  time  should  have  personal  attention, 
no  matter  how  rich  or  influential  the  person  may  be,  and 
this  rule  generally  works  out  right. 

Liability  of  Stockholders 

In  the  case  of  a  corporation  becoming  involved,  and 
unable  to  pay  its  debts,  the  stockholders  in  some  few  states 
become  personally  responsible,  in  proportion  to  their 
holdings ;  and  in  these  states  it  is  possible  to  collect  either 
in  part  or  in  full  from  the  individuals,  though  the  corpora- 
tion is  insolvent.  Even  in  these  states  great  care  should 
be  taken  in  selling  to  a  corporation  that  is  still  in  process 
of  organization,  as  a  stockholder  is  only  responsible  for 
debts  incurred  after  he  has  acquired  his  stock,  even  though 
he  may  be  an  owner  at  time  of  delivery  of  merchandise, 
and  derive  the  benefit  from  same. 

There  was  an  occurrence  of  this  kind  a  few  years  ago, 
when  a  large  hotel  corporation  was  being  projected.  The 
proposed  stockholders  had  agreed  to  organize  as  soon  as 
certain  legal  details  were  completed;  a  manager  was 


H4  MERCANTILE  CREDITS 

engaged;  much  of  the  money  had  been  paid  in;  and  the 
building  was  in  course  of  construction.  In  order  to  obtain 
in  time,  certain  supplies  which  had  to  be  manufactured  in 
the  East,  orders  were  placed  by  the  manager  in  October, 
delivery  to  be  made  in  January.  The  organization  was 
not  completed  nor  stock  issued  until  December.  All  the 
forms,  however,  had  been  regularly  complied  with  before 
arrival  or  delivery  of  the  merchandise.  In  April,  the 
corporation,  through  bad  management,  went  into  the 
hands  of  a  receiver,  and  there  was  nothing  left — after  the 
building  material  men  were  taken  care  of — for  unsecured 
creditors. 

Suit  was  brought  by  the  Eastern  firm  against  the 
stockholders,  on  their  personal  liability  as  stockholders. 
After  a  long,  tedious  time  in  court,  the  case  was  decided 
against  the  firm,  for  the  reason  that  the  stockholders  had 
not  acquired  their  stock  at  the  time  the  order  was  placed, 
although  they  were  bona  fide  stockholders  when  merchan- 
dise was  delivered,  and  had  accepted  and  used  the  same, 
and  refused  to  relinquish  title  to  the  property. 

Staving  Off  Disaster 

Occasionally  a  good  business  man,  with  good  oppor- 
tunities, will  become  involved;  and  through  misfortune,  or 
some  cause  for  which  he  is  not  responsible,  will  be  unable 
to  meet  his  obligations.  Then,  unless  he  is  helped  finan- 
cially, and  an  extension  granted,  he  faces  sure  ruin.  In 
such  cases  a  general  meeting  of  creditors  should  be  called, 
so  as  to  prevent  any  one  firm  taking  undue  advantage.  By 
this  means  a  firm  is  often  saved  from  ruin,  and  in  a  reason- 
able time  is  again  on  a  profitable  basis. 

Local  boards  of  trade  have  done  much  good  along 
these  lines.  They  have  also  assisted  in  making  satisfac- 


CREDITS  AND  COLLECTIONS  115 

tory  adjustments,  and  in  the  selling  and  handling  of  stocks 
of  goods  for  the  benefit  of  both  debtor  and  creditor. 

Conditional  Sales 

In  many  lines  of  merchandise  it  is  possible  to  handle 
accounts  in  a  way  that  is  practically  free  from  danger  of 
loss,  by  selling  on  a  lease,  or  conditional  sale  contract, 
whereby  the  title  of  the  property  does  not  pass  to  the  pur- 
chaser until  entirely  paid  for.  This  plan  is  being  followed 
very  extensively  on  all  classes  of  merchandise  except 
perishable  goods,  or  such  as  are  consumed  in  use,  like 
groceries.  The  form  of  contract  used  is  very  simple ;  and 
it  is  not  necessary  that  it  should  be  recorded.  Failure  to 
pay  as  agreed  is  sufficient  cause  for  removal  of  goods.  If, 
however,  a  fairly  large  payment  has  been  made  in  ad- 
vance, the  purchaser  is  sure  to  pay  the  balance  if  possible, 
when  due.  Merchandise  held  under  such  contract  cannot 
be  sold  by  the  purchaser  or  removed,  nor  is  it  subject  to 
attachment. 

Cooperation  Among  Credit  Men 

Friendly  relations  should  be  encouraged  between  the 
credit  departments  of  competing  firms,  for  mutual  assis- 
tance and  the  exchange  of  information  on  slow  or  doubt- 
ful accounts.  The  services  of  the  commercial  agencies 
also  are  always  necessary  and  valuable. 

Collection  Agencies 

Many  collection  agencies  exist  throughout  the  United 
States,  a  few  of  which  are  good,  and  sometimes  able  to 
collect  bad  accounts  which  have  been  given  up  by  the  firms 
holding  them.  Great  care  should  be  exercised  in  employ- 
ing such  agencies,  however,  as  far  too  many  are  irrespon- 


n6  MERCANTILE  CREDITS 

sible  and  do  not  turn  in  the  money  collected.  It  is  my 
opinion  that  a  properly  organized  collection  department 
can  do  about  as  good  work  on  bad  accounts  as  any  out- 
side firm,  although  such  accounts  are  disagreeable,  and 
require  a  great  deal  of  labor  and  time. 

But  a  collector  will  not  be  a  success  unless  he  thrives 
on  work,  and  is  willing  to  patiently  labor,  day  after  day, 
until  he  can  bring  results. 

Successful  Strategy 

Strategy,  new  methods,  and  timely  schemes,  are  neces- 
sary to  bring  results  on  many  of  the  accounts  that  have 
become  habitually  slow. 

On  one  occasion  a  dealer  in  Santa  Barbara  had  per- 
sistently maneuvered  to  avoid  paying  a  $300  account  that 
was  over  a  year  old.  He  had  a  fair  standing,  and  we 
hesitated  to  bring  suit,  yet  could  not  afford  to  sell  him 
any  more  goods  without  a  settlement.  Knowing  that  he 
would  take  in  considerable  money  during  December,  we 
wrote  him  that  we  had  divided  his  account  into  ten  dis- 
tinct parts,  making  a  draft  for  each  amount,  and  dating 
the  drafts  in  such  a  way  that  one  would  be  presented  each 
day,  beginning  with  the  I5th  of  December.  The  amounts 
were  small  in  the  earlier  drafts,  and  made  larger  as  they 
came  nearer  to  December  25th.  We  arranged  with  the 
Bank  at  Santa  Barbara  to  wire  us  in  case  any  draft  was 
not  paid  promptly,  and  also  engaged  an  attorney,  telling 
him  to  be  ready  to  file  suit  in  case  we  notified  him.  All 
the  details  of  the  arrangements  were  explained  to  the 
debtor,  and  he  knew  that  if  he  failed  to  pay  as  arranged, 
his  place  would  be  attached  during  his  holiday  business. 
The  scheme  worked  well  and  the  entire  account  was  paid. 
Strange  to  say,  he  took  no  offense  and  has  since  given  us 
business,  but  on  a  cash  basis. 


CREDITS  AND  COLLECTIONS  117 

Hard  Work 

The  way  of  the  collector  is  always  hard.  There  is  no 
quick  and  easy  way  to  collect  all  accounts,  but  persistent 
work  will  count;  and  the  heart  of  the  collector  will  fre- 
quently be  cheered  by  some  unexpected  pleasure,  such  as 
the  payment  of  an  old  or  outlawed  debt. 


CHAPTER   VII 

AUDITS  AND  INVESTIGATIONS 
BY  W.  C.  MUSHET,  C  P.  A. 

In  taking  up  the  subject  of  accounting  in  relation  to 
credits,  I  wish  to  speak  of  credit  in  a  rather  comprehensive 
way,  and  there  is  one  central  thought  that  I  wish  particu- 
larly to  emphasize,  and  that  is  the  importance  and  neces- 
sity of  strict  investigation  in  all  matters  relating  to  credits. 
In  this  investigation  accountancy  will  frequently  play  an 
important  part. 

Sources  of  ^Information 

Now,  with  regard  to  merchandising.  What  is  it  that 
a  merchant  wishes  to  know  about  accounting  in  relation  to 
credits?  He  wants  to  know  the  financial  standing  of  his 
customer.  But  he  does  not  want  to  stop  there;  he  also 
wants  to  know  the  history  of  his  customer's  business,  and 
where  can  he  get  that  information? 

Well,  he  goes  to  Bradstreet,  and  he  goes  to  Dun,  ask- 
ing for  the  commercial  standing  of  this  or  that  man;  and 
he  gets  a  report  which  purports  to  tell  him  what  that  man's 
assets  are,  and  what  his  liabilities  are,  and  what  is  his  net 
worth.  But  where  do  Bradstreet  and  Dun  get  their  infor- 
mation? First,  they  go  to  the  prospective  customer  and 
ask  him  for  a  statement.  They  ask  him  to  tell  them  about 
himself. 

118 


AUDITS  AND  INVESTIGATIONS  119 

Mr.  Isaacstein's  Mistake 

I  remember  a  story  here  that  illustrates  the  point  I 
want  to  make.  One  day,  early  in  March,  a  man  with  a 
handful  of  papers  went  into  a  store  on  Main  Street — I 
don't  know  whose  store,  but  we  will  say  it  was  Mr.  Isaac- 
stein's — and  he  said,  taking  out  his  papers,  "I  would  like 
to  find  out  how  much  stock  you  have  got."  Mr.  Isaac- 
stein  suddenly  became  very  busy — so  busy  he  could  not 
stop  to  make  a  calculation — but  volunteered  in  a  very 
large  way,  "Well,  we  have  got  about  $10,000  worth  of 
stock  on  the  shelves."  "Yes.  And  how  many  solvent 
creditors  have  you  got?  How  much  is  owing  to  you  that 
you  consider  good?"  "About  $5,000."  "Well,  how 
much  do  you  owe?"  "Don't  owe  anything."  "Good," 
said  the  inquirer.  "I'll  see  you  later."  So  that  afternoon 
he  returned  to  the  store,  and  taking  out  his  papers,  an- 
nounced, "I  have  come  to  collect  your  personal  property 
tax."  "Well,"  said  Mr.  Isaacstein,  not  remembering  him, 
"I  suppose  you  want  to  find  out  what  property  I  have 
got."  "Why,  no,"  explained  his  caller;  "I  was  here  this 
morning,  and  you  told  me."  And  he  assessed  him  accord- 
ingly. Mr.  Isaacstein  was  angry,  and  said,  "My  friend, 
you  did  not  treat  me  right.  I  thought  that  you  were  a 
Dun  or  Bradstreet  man  1" 

Credit  Misinformation 

You  will  note  that  it  is  not  a  legal  crime  to  lie  to  Dun 
or  Bradstreet.  If  it  were,  there  would  be  no  necessity  for 
the  act  now  before  the  California  State  Legislature  to 
make  it  a  crime  for  a  man  to  make  a  false  statement  in 
writing  to  either  of  these  agencies. 

Dun  and  Bradstreet  do  not  rely  entirely  on  the  state- 
ment of  the  party  himself,  but  make  every  effort  to  get 


120  MERCANTILE  CREDITS 

corroborative  evidence.  They  go  to  the  creditors  of  the 
man  that  they  are  investigating,  and  also  to  the  bankers, 
but  they  do  not  always  get  the  truth  even  from  those 
people.  I  remember  the  case  of  a  man  in  Arizona  who 
was  on  the  verge  of  failure  and  owed  the  bank  in  his  town 
some  six  or  seven  thousand  dollars.  He  wanted  to  trans- 
fer his  account  from  that  bank  to  one  of  the  very  large 
banks  in  a  distant  city,  and  the  two  bankers  had  some 
correspondence  on  the  subject.  The  local  banker,  know- 
ing the  true  conditions,  and  wishing  to  uget  from  under," 
gave  the  debtor  a  very  excellent  reputation,  and  the  ac- 
count was  removed  from  Arizona  to  the  distant  city,  to 
which  news  of  the  depositor's  failure  came  some  few 
weeks  later.  It  is  evident  from  this  that  sometimes  even 
a  banker,  in  order  to  save  himself,  will  give  an  incorrect 
statement  regarding  a  debtor. 

Board  of  Trade  Reports 

Of  course  the  agencies  do  the  best  they  can.  They  get 
the  information;  but  the  information  that  they  get  neces- 
sarily must  come  chiefly  from  the  debtor  and  from  the 
references  that  he  gives. 

For  the  betterment  of  this  condition  the  Los  Angeles 
Board  of  Trade  maintains  a  reporting  bureau,  which  gets 
a  great  deal  of  advantageous  information  for  the  credit 
man.  Similar  bureaus  are  maintained  in  many  other 
cities.  The  plan  works  something  like  this :  Mr.  Jones 
of  Los  Angeles  has  applied  to  you  for  credit.  You  want 
to  know  how  he  stands,  and  you  send  an  inquiry  to  the 
board  of  trade.  The  board  of  trade  will  list  all  such 
persons  inquired  about,  and  that  list  will  be  circulated 
through  the  trade,  and  the  next  day  the  information  re- 
ceived will  be  tabulated.  In  this  way  the  board  finds  out 
each  day,  or  as  often  as  called  upon,  how  much  a  certain 


AUDITS  AND  INVESTIGATIONS  121 

man  owes  at  a  certain  time,  and  how  much  is  past  due;  and 
also  gets  information  as  to  the  character  of  the  payments. 
But  this  report,  you  see,  deals  only  with  the  liabilities  of 
the  man.  Next,  they  send  out  a  request  to  the  party  for  a 
statement;  that  is,  they  send  him  a  form  asking  him  to 
make  his  own  statement  about  his  affairs. 

i 
Scope  of  Statement 

Now,  all  these  things  deal  with  the  present  condition 
of  the  debtor's  account.  But  that  is  not  sufficient.  It  is 
necessary  to  know  how  that  man  stands  today,  but  you 
want  more  than  that.  You  want  a  history  of  his  business. 
You  want  a  certified  statement  from  his  books  and  records. 

But  what  are  you  going  to  do  when  there  are  no 
books?  Unfortunately,  many  a  small  merchant  does  not 
keep  books  in  any  real  sense.  You  will  find  in  his  store  a 
couple  of  spindles,  on  one  of  which  he  puts  the  bills  as 
they  come  in,  while  on  the  other  he  puts  the  bills  as  he 
pays  them.  He  may  also  have  a  blotter  in  which  he  re- 
cords the  sales  he  makes  on  credit.  Sometimes  you  will 
find  both  a  blotter  and  a  cash  record,  but  there  will  still  be 
absolutely  no  record  of  his  investment.  What  is  to  be 
done  under  such  conditions? 

Proper  Records 

Of  course,  we  have  the  remedy  for  this  condition  in 
our  own  hands.  In  England,  it  is  a  statutory  offense  for  a 
retailer  not  to  keep  a  set  of  books;  and  a  like  condition 
can  be  brought  about  in  this  country.  But  at  present,  in  a 
case  where  there  are  no  books,  all  that  you  can  do  is  to  in- 
vestigate the  past  history  of  the  concern,  and  insist  that  in 
the  future  some  fundamental  records  shall  be  kept.  You 
already  require  your  customers  to  carry  fire  insurance. 


122  MERCANTILE  CREDITS 

Insist  on  their  keeping  proper  records,  just  as  you  insist  on 
their  carrying  fire  insurance.  Require  them  to  keep  simple 
records  of  account,  not  only  for  your  benefit,  but  for  the 
benefit  of  the  owner  of  the  business  himself. 

Incomplete  Statements 

But  suppose  that  a  proper  set  of  books  is  kept,  what  is 
necessary?  You  want  a  certified  statement  from  those 
books  and  records,  and  you  want  the  whole  truth.  Not  a 
part  of  the  truth,  but  the  whole  truth.  I  remember  an 
instance  in  point.  A  certain  concern  in  my  town  was  in  dif- 
ficulties ;  and  a  statement  signed  by  a  certified  accountant 
was  placed  upon  my  desk,  showing  that  the  assets  were 
$123,000  and  the  liabilities  were  $100,000.  That  looked 
as  if  there  were  a  surplus  of  $23,000.  The  business  had 
been  running  for  only  ten  months,  and  it  appeared  that  it 
had  made  $23,000  profit  in  that  short  period.  But  when 
I  made  a  personal  investigation,  this  is  about  what  I  found. 
The  assets  on  the  ledger  were  apparently  $123,000,  and 
the  liabilities  were  $100,000.  The  expenses  stood  at  about 
$60,000,  making  the  gross  gain  $83,000.  Yet  this  com- 
pany, instead  of  making  a  profit  of  $23,000,  had  actually 
made  a  loss  of  $27,000.  But,  as  it  would  not  help  the  sale 
of  its  stock  to  go  before  the  purchasing  public  with  a 
statement  showing  a  $27,000  loss  in  operating  in  ten 
months,  the  officers  of  the  company  asked  an  accountant 
to  tell  them  what  they  should  do.  The  accountant  went 
home  that  night,  after  inspecting  the  books,  and  dreamed 
that  some  timber  lands  owned  by  the  company  up  in  Ore- 
gon had  increased  in  value  from  $50,000  to  $100,000. 
Accordingly,  he  put  a  profit  of  $50,000  on  one  side  of  the 
ledger,  to  balance  the  loss  of  $27,000  which  appeared  on 
the  other  side,  and  the  result  of  this  was  an  apparent  net 
profit  of  $23,000.  A  number  of  indictments  followed  this 


AUDITS  AND  INVESTIGATIONS  123 

discovery,  and  two  of  the  manipulators  of  that  fraudulent 
corporation  are  now  serving  time. 

Yet  the  books  were  technically  correct,  and  the  book- 
keeper, a  German,  kept  them  magnificently,  with  faultless 
neatness  and  accuracy.  But  he  was  a  mechanical  book- 
keeper. After  he  had  written  the  books  up,  he  did  not 
understand  what  they  spelt,  and  the  poor  fellow  invested 
$7,000  of  his  own  money  in  that  fraudulent  concern,  and 
lost  it,  simply  because  he  could  not  read  the  handwriting 
on  the  wall,  though  he  had  written  it  with  his  own  hand. 

Profit  and  Loss  Statements 

I  repeat  to  you,  therefore :  When  you  get  a  statement, 
get  a  statement  of  the  whole  truth.  It  is  very  easy  to  cover 
a  multitude  of  sins  by  saying:  Assets,  $123,000;  Liabili- 
ties, $100,000;  Surplus,  $23,000;  but  that  is  only  half  the 
truth.  This  is  an  asset  and  liability  statement — a  capital 
statement — and  it  does  not  say  a  word  about  profit  and 
loss.  You  can  take  up  any  newspaper,  you  can  take  up  any 
report  of  any  institution  in  America,  and  all  you  get  is  a 
statement  of  assets  and  liabilities;  that  is,  just  one-half  of 
the  truth.  But,  if  you  had  all  the  debits  and  all  the  credits 
— a  capital  statement  and  also  a  profit  and  loss  statement 
— then  you  would  know  what  was  going  on.  In  the  in- 
stance just  quoted,  if,  instead  of  merely  giving  an  asset  and 
liability  statement,  and  showing  a  surplus  of  $23,000, 
there  had  also  been  a  gain  and  loss  statement,  the  $50,000 
in  assets  which  had  been  thrown  into  the  accounts  would 
have  been  disclosed,  and  people  would  have  asked  where 
that  $50,000  came  from.  Then  they  would  have  discov- 
ered that  it  was  not  an  operating  profit.  There  was,  in 
fact,  an  operating  loss  of  $27,000;  and  even  admitting, 
for  the  sake  of  argument,  that  the  price  of  that  Oregon 
property  had  actually  increased  $50,000,  that  increase 


124  MERCANTILE  CREDITS 

was  a  capital  increase  and  not  an  increase  from  operation. 
There  are  two  kinds  of  profit — a  profit  from  opera- 
tion, and  a  capital  profit.  And  if  a  statement  submitted 
shows  the  difference  between  these  two  kinds  of  profit,  you 
will  get  the  whole  truth  and  not  half  of  it. 

Responsibility  of  the  Accountant 

In  the  case  just  cited,  the  accountant  deliberately  made 
a  false  report,  and  was  as  guilty  as  the  officers  of  the  com- 
pany who  were  indicted  for  fraud.  There  should  be  some 
means  of  holding  an  accountant  responsible  under  such  cir- 
cumstances. In  England  they  manage  things  of  this  kind 
differently.  The  English  Corporation  Act  requires  that 
any  company  selling  stock  to  the  public  shall  have  an  audi- 
tor appointed  by  the  stockholders — not  by  the  officers  and 
manipulators  of  the  corporation — who  makes  a  semi- 
annual examination.  He  then  reports  to  the  stockholders, 
and  he  must  give  them  not  only  an  asset  and  liability  state- 
ment, but  a  gain  and  loss  statement  also. 

Now,  that  is  what  we  should  insist  upon.  A  merchant 
wants  to  know,  not  only  what  a  customer  is  worth  today, 
but  how  much  he  has  made  or  lost  in  his  business  during  a 
definite  period  of  time. 

A  lawyer  came  to  me  some  time  ago  for  advice  in  re- 
gard to  a  client  of  his.  This  client  had  entered  into  part- 
nership with  another  man  a  year  or  two  before,  and  each 
of  them  had  invested  $1,800,  making  $3,600  altogether, 
which  constituted  the  assets  of  the  business.  His  client, 
however,  had  put  in  $1,800  of  actual  money,  while  the 
other  partner  had  put  in  his  business  at  an  estimated  net 
worth  of  $1,800;  that  is,  he  claimed  the  assets  were  worth 
$1,800  net,  over  and  above  the  liabilities.  No  statement 
of  profit  and  loss  was  shown,  and  in  the  course  of  the  year 
it  was  found  that  the  real  value  of  the  business  had  only 


AUDITS  AND  INVESTIGATIONS  125 

been  $900 — just  half  of  what  was  stated.  In  other  words, 
my  friend's  client  had  been  swindled,  and  the  original 
assets  of  the  firm  were  only  $2,700.  The  business  was 
continued,  but  lost  money  right  along.  "We  have  just 
taken  stock,"  said  the  partner  who  had  invested  the  cash, 
"and  find  that  the  assets  figure  $3,000,  and  the  liabilities 
$1,800,  so  that  all  we  are  worth  is  $1,200  as  against 
$2,700  a  year  ago.  In  other  words,  we  lost  $1,500." 

Now,  that  is  what  the  merchant  wants  to  know.  It  is 
true  that  he  is  interested  in  knowing  that  the  assets  today 
are  $3,000,  and  that  the  liabilities  are  $1,800,  and  that 
there  is  a  real  investment  there  of  $1,200.  He  wants  to 
know  that;  but  he  also  wants  to  know  that  during  the  year 
the  investment  has  dropped  from  $2,700  to  $1,200,  and 
that  there  has  been  a  loss,  if  such  is  the  case.  He  should 
know  that,  although  the  principal  is  still  alive,  it  is  in  a  pre- 
carious condition,  and  he  will  never  find  it  out  from  an 
asset  and  liability  statement.  He  must  have  the  whole 
truth  in  order  to  make  an  intelligent  decision,  and  that  is 
why  I  am  insisting  upon  the  necessity  of  showing  the  losses 
and  the  gains,  as  well  as  the  assets  and  liabilities. 

Optimism  is  Natural 

A  man  making  a  statement  of  his  own  affairs  will  nat- 
urally put  his  best  foot  forward.  He  will  even  deceive 
himself.  He  is  optimistic.  He  will  inflate,  in  his  mind, 
the  assets,  and  he  will  deflate  the  liabilities.  You  know 
Bob  Burdette's  story  about  the  optimist  and  the  pessimist. 
"The  pessimist  says,  'I  wonder  if  there  is  any  milk  in  that 
pitcher!'  And  the  optimist  says,  'Pass  the  cream  !'  "  Busi- 
ness men  are  all  optimists  naturally,  or  should  be.  They 
are  going  to  put  their  best  foot  forward.  They  are  going 
to  make  things  look  as  rosy  as  they  can,  and  it  is  for  the 
credit  men  to  get  right  down  to  the  true  facts. 


126  MERCANTILE  CREDITS 

Inflated  Assets 

Not  very  long  since,  I  was  going  over  the  books  of  a 
large  water  company,  and  we  put  in  a  record  of  material. 
I  had  them  take  stock  of  the  material,  and  compare  it  with 
their  material  account  upon  the  ledger,  and  they  discov- 
ered that  the  material  by  actual  count  was  about  $1,800 
less  than  the  material  account  upon  the  ledger.  A  few 
days  afterward  they  had  adjusted  this  difference.  They 
did  not  alter  the  ledger  account,  but  they  fixed  the  ma- 
terial, which,  from  my  point  of  view,  means  that  there  is 
an  inflation  of  $1,800  in  the  material  account. 

Depreciation  of  Assets 

In  our  investigations  we  must  not  only  watch  for  in- 
flation of  values,  but  must  also  watch  to  see  that  proper 
allowance  has  been  made  for  depreciation.  Sometimes  the 
allowance  is  too  small,  and  occasionally  it  is  too  large.  I 
once  knew  a  gentleman  in  the  agricultural  implement  busi- 
ness who,  when  he  took  his  inventory  at  the  end  of  the 
year,  wrote  off  50  per  cent  of  any  merchandise  that  was 
on  hand  the  year  before.  In  other  words,  if  it  had  not 
moved  during  the  year,  he  considered  that  half  its  value 
had  gone.  If  it  had  come  in  during  the  year,  depreciation 
was  reckoned  on  a  lower  scale;  but  if  it  had  been  on  the 
inventory  two  years  before,  he  depreciated  it  100  per  cent. 
He  simply  listed  it.  Now,  that  may  be  a  little  extreme; 
but  you  will  often  find,  when  you  come  to  scrutinize  a  list 
of  assets  handed  you,  that  the  person  responsible  has 
gone  to  the  other  extreme,  and  has  made  no  allowance 
whatever  for  depreciation. 

Accounts  Receivable 

Then  again,  some  people  will  carry  accounts  receivable 
on  the  books  for  years  and  years.  They  don't  write  them 


AUDITS  AND  INVESTIGATIONS  127 

off  because  they  look  like  an  asset.  Notes  receivable  are 
often  treated  in  the  same  way.  I  remember  such  a  case 
some  years  ago.  There  were  two  boards  of  trade  in  a 
certain  city,  and  naturally  they  were  antagonistic.  The 
standing  of  a  debtor  had  been  submitted  to  one  of  these 
boards,  which,  after  a  little  investigation,  said  to  the  man: 
uOh,  everything  is  all  right,  we  will  give  you  an  extension 
of  time;  go  on  and  attend  to  your  business,  and  we  will 
see  that  your  creditors  do  not  make  you  any  trouble. 
Leave  it  to  us."  One  of  the  creditors,  however,  brought 
that  man  into  the  other  board  of  trade,  with  which  I  was 
connected,  and  we  also  went  through  his  affairs,  and  our 
report  was  very  different — so  different  that  his  creditors 
said:  "This  man's  condition  is  so  serious  that,  in  order 
to  protect  ourselves,  we  must  take  a  transfer  of  his  assets. 
He  is  not  in  a  fit  condition  to  run  his  business,  and  his  busi- 
ness is  not  in  a  fit  condition  to  be  run  by  him ;  he  has  lost 
too  much  money  already." 

Now,  where  did  the  difference  come  in  the  viewpoint 
of  those  two  boards?  Right  in  notes  receivable.  When 
we  came  to  scrutinize  the  seven  or  eight  thousand  dollars 
of  notes  receivable  listed  as  assets,  we  found  they  were 
notes  given  by  an  individual  member  of  the  firm  to  the 
firm.  The  man  was  listing  as  assets  his  own  notes ! 

Understanding  the  Liabilities 

As  to  liabilities,  they  are  very  apt  to  be  understated. 
I  could  narrate  to  you  from  my  own  experience  numbers 
of  cases  where  companies  have  understated  their  liabili- 
ties. In  one  concern  that  we  investigated,  we  had  to  make 
adjustments  of  the  aggregate  amount  of  $108,000,  debit 
and  credit,  in  order  to  put  a  true  record  on  the  books  as 
of  a  certain  date.  And  that  meant  that  this  concern,  which 
had  been  paying  dividends  in  the  belief  that  it  was  solvent, 


128  MERCANTILE  CREDITS 

as  a  matter  of  fact,  had  not  made  any  profit,  but  had  been 
running  at  a  loss  and  did  not  know  it.  Now,  if  the  concern 
itself  did  not  know  it,  how  were  its  creditors  to  find  it  out 
without  an  investigation  ? 

The  Public  Needs  Protection 

If  a  merchant  needs  a  credit  man  to  look  after  his  busi- 
ness for  him,  how  much  more  does  the  public  need  a  credit 
man  to  look  after  its  business  ?  It  is  popularly  supposed 
that  the  public  likes  to  be  humbugged.  That  may  be  true 
politically,  but  I  do  not  think  it  is  financially.  It  is  a  com- 
mon saying  that  a  sucker  is  born  every  minute.  That  may 
be  true  in  one  sense.  It  is  also  said  that  the  best  bet  is  the 
public  apathy.  As  a  matter  of  fact,  Get-rich-quick  Wal- 
lingfords  in  this  country  get  millions  of  dollars  from  the 
unsuspecting  public  every  year. 

What  we  need  is  a  law  which  will  force  all  stock-sell- 
ing corporations  to  tell  the  whole  truth,  and  let  us  have  the 
operation  account  as  well  as  the  statement  of  assets  and 
liabilities.  The  public  wants  to  see  that  profit  and  loss 
statement.  It  is  all  right  to  have  a  statement  of  assets  and 
liabilities;  that  is  good  as  far  as  it  goes ;  but  it  is  only  one- 
half  the  truth;  and  if  I  must  have  but  half,  the  half  of  the 
truth  that  I  prefer  to  have  before  me  is  the  profit  and  loss 
statement,  which  shows  where  the  profits — if  there  are 
any — come  from.  When  you  find  that  out,  you  know 

where  you  are. 

< 

Building  Associations 

Now,  I  want  to  tell  you  about  home  building  associa- 
tions. There  are  many  of  them,  and  some  are  better  than 
others,  but  they  should  all  be  investigated  before  you  trust 
your  money  to  them.  Let  me  give  you  a  typical  statement: 


AUDITS  AND  INVESTIGATIONS 
Operation,  one  year: 

Legitimate  profits $10,000 

Rise  in  the  value  of  real  estate 70,000 

Premiums  on  sale  of  stock 20,000 


129 


Total $100,000 

Now,  they  had  made  an  operating  loss : 

Expenses $90,000 

Dividends 10,000 

Total $100,000 

As  you  will  note,  the  profits  were  made  by  raising  the 
assets  value.  They  threw  the  increase  into  the  gain 
column.  The  stockholders  got  in  on  the  ground  floor,  but 
the  manipulators  got  in  at  the  sub-basement! 

An  accountant  came  to  me  today  and  said :  uThe  com- 
pany I  am  investigating  has  been  operating  at  a  loss,  but 
the  directors  have  declared  a  dividend,  and  are  carrying  a 
surplus  over  into  the  next  year.  How  can  this  be?"  I 
explained  to  him  the  method:  Buy  a  piece  of  property 
today  for  $100,000.  Go  home,  go  to  sleep,  have  a  dream. 
Tomorrow  morning  put  it  on  the  books  at  $200,000. 
Profits  $100,000 !  What  a  fine  investment!  Of  course,  a 
rise  in  the  price  of  stock  follows;  and  when  stock  rises  and 
the  premium  is  paid  on  it,  then  take  the  premium  for 
profit.  You  receive  $200  for  stock,  par  value  $100,  and 
you  put  the  $100  on  the  books  as  a  liability — a  capital  lia- 
bility of  the  stock,  while  the  premium  is  a  profit  thrown 
into  the  gain  column. 

Then  dividends ;  and  so  on,  and  so  on,  until  the  crash 
comes,  as  it  is  bound  to  come  sooner  or  later.  And  what 
then?  They  have  been  discounting  future  dividends.  If 
the  company  is  paying  all  the  profits  in  dividends  now, 
then  when  the  stock  is  all  sold  and  there  are  no  more 
premiums  and  property  ceases  to  rise  in  value,  or  is  sold 
at  an  increased  price  which  has  already  been  taken  into 


1 30  MERCANTILE  CREDITS 

consideration  and  declared  as  dividends,  what  is  going  to 
happen?  First,  the  dividends  will  grow  smaller;  by  and 
by  the  dividends  will  pass;  and  then  there  will  be  assess- 
ments. This  is  not  a  guess ;  it  is  something  that  is  happen- 
ing, not  occasionally,  but  continually. 

Necessity  for  Surplus 

Now,  when  assessments  come,  there  will  be  a  fall  in 
the  price  of  that  stock;  and  when  the  stock  falls  in  price, 
there  will  be  a  panic  among  the  stockholders;  and  when 
the  panic  comes,  there  will  be  a  further  fall  in  the  price 
of  stock;  and  so  on.  This  is  the  penalty  for  such  manipula- 
tion. To  inflate  values  is  unsound  accounting,  is  unsound 
financiering,  is  unsound  legally. 

To  illustrate  the  danger  of  such  inflation,  I  may  men- 
tion the  case  of  a  man  who  paid  $30,000  for  an  orange 
grove  in  Southern  California  just  before  the  severe  win- 
ter which  destroyed  the  groves  in  that  part  of  the  state. 
Three  months  after  he  purchased  the  grove  he  was  beg- 
ging someone  to  take  it  off  his  hands  at  $15,000.  That 
winter  meant  to  Southern  California  a  loss  of  millions  of 
dollars.  Such  calamities  must  be  provided  for;  and  to 
offset  these  is  a  good  way  to  dispose  of  that  rise  in  the 
value  of  property.  And  right  here  I  want  to  quote  a  para- 
graph in  regard  to  a  court  decision  on  the  matter  of  pay- 
ing dividends  in  anticipation  of  profits.  This  is  a  New 
York  case,  in  which  the  court  said :  "To  calculate  months 
in  advance  on  the  result  of  future  transactions  and  on  such 
calculations  to  declare  dividends,  was  to  base  dividends  on 
paper  profits,  hoped-for  profits,  future  profits,  and  not 
upon  the  surplus  or  net  profits  required  by  law." 

The  Proper  Treatment  of  Unearned  Increment 

A  very  wealthy  corporation  bought  considerable  land 
a  number  of  years  ago,  and  has  held  most  of  it  since.  That 


AUDITS  AND  INVESTIGATIONS  131 

property  stood  on  the  books  at  a  million  dollars ;  but  at  a 
conservative  estimate  it  has  risen  in  value  during  the  last 
ten  or  fifteen  years  to,  we  will  say,  $2,000,000.  The  cor- 
poration still  has  the  property,  or  a  great  deal  of  it.  Now, 
in  1909  the  Federal  Government  passed  an  income  tax 
requiring  the  payment  of  i  per  cent  upon  all  profits  over 
and  above  $5,000.  The  Government  does  better  for  it- 
self now,  for  under  the  present  law  it  takes  the  tax  on  the 
entire  corporate  profits;  but  in  1909  it  was  satisfied  with 
less.  Now,  here  was  a  company  with  land  upon  its  books 
at  a  million  dollars,  which  was  worth  $2,000,000,  and 
this  gave  a  million  dollars  of  profits  right  there. 

For  better  illustration,  take  a  single  piece  of  the  prop- 
erty that  the  corporation  bought  fifteen  years  ago.  We 
will  say  it  cost  $1,000,  and  could  be  sold  for  $2,000  in 
1909,  and  in  1910  for  $2,200.  The  company  had  made  a 
profit  there  of  $1,200,  but  how  much  was  the  Government 
to  get  out  of  that?  Should  the  Government  take  its  i  per 
cent  on  the  total  profit,  or  only  on  the  increase  from  1909 
to  1910,  which  was  but  $200? 

Here  it  is  obvious  that  the  Government  should  only 
tax  the  increase  after  the  law  went  into  effect  in  1909, 
when  the  property  was  already  worth  $2,000,  until  1910, 
when  it  was  worth — and  was  sold  for — $2,200,  a  profit  of 
$200.  On  this  the  Government  was  entitled  to  its  i  per 
cent. 

After  the  passing  of  the  income  tax  law  it  became  nec- 
essary to  put  the  property  on  the  books  as  of  the  new  valu- 
ation; that  is,  $2,000,  just  twice  the  original  cost.  This 
gain  of  a  thousand  dollars,  however,  was  not  put  in  the 
Profit  and  Loss  account,  but  was  put,  as  an  offsetting  lia- 
bility, into  a  capital  surplus  account;  and  when  the  prop- 
erty was  sold  for  $2,200,  the  profit  of  $200  was  added  to 
the  $  1,000  in  the  liability  account,  which,  when  taken  out 


I32  MERCANTILE  CREDITS 

and  put  with  the  $200  in  the  gain  column,  made  a  total 
realized  profit  of  $1,200. 

Dividends  from  Premiums 

I  will  now  briefly  discuss  the  subject  of  premiums  on 
the  sale  of  stock  as  a  profit  out  of  which  to  declare  divi- 
dends. Section  309  of  the  Civil  Code  of  the  State  of  Cali- 
fornia says  that  dividends  must  not  be  paid  except  from 
surplus  profits  arising  from  the  business  of  the  corpora- 
tion. Most  of  the  states  have  similar  laws.  If  the  busi- 
ness of  the  corporation  is  to  sell  its  own  stock  and  make  a 
profit  on  it,  then  premiums  can  go  into  the  gain  column, 
but  I  do  not  think  that  any  corporation  will  claim  that  its 
business  is  to  deal  in  its  own  stock.  I  do  know  of  one  cor- 
poration, however,  whose  only  business  for  six  or  seven 
years  has  been  to  sell  its  own  stock;  and  it  has  declared 
dividends,  not  once  but  many  times,  absolutely  without 
any  justification.  In  all  the  years  of  its  existence  its  legiti- 
mate profits  have  not  amounted  to  $3,000,  but  it  has 
traded  notes  which  it  took  for  its  own  stock  to  another 
concern,  and  has  gone  on  accruing  interest  on  those  notes 
which  it  did  not  own,  putting  that  accrued  interest  upon 
its  books,  calling  it  profits,  and  declaring  dividends  out  of 
those  profits.  I  attended  a  recent  stockholders'  meeting. 
They  decided  to  lease  a  piece  of  property,  and  immedi- 
ately the  value  of  that  lease  was  put  on  the  books  as  $50,- 
ooo,  and  dividends  were  declared  on  the  strength  of  the 
profit  thus  disclosed.  The  district  attorney  will  tell  you 
that  the  improper  declaration  of  dividends  out  of  capital  is 
only  a  misdemeanor,  it  is  not  a  felony. 

That  company  is  not  declaring  dividends  now,  and  a 
poor  woman  came  to  me,  and  said,  "What  am  I  to  do?  I 
haven't  very  much  money,  and  I  put  $1,000  into  this  thing, 
not  for  myself,  but  for  a  niece  in  Philadelphia,  whose  hus- 


AUDITS  AND  INVESTIGATIONS  133 

band  is  bedridden,  for  it  was  expected  to  pay  10  per  cent, 
or  12  per  cent,  and  that  would  have  meant  $10  a  month 
for  my  niece  and  her  husband.  I  don't  know  how  on  earth 
they  are  going  to  get  along  without  that  $10."  But  the 
manipulators  of  that  company  are  living  in  mansions  that 
cost  $100,000,  and  they  ride  in  their  automobiles. 

I  know  of  another  case  where  the  victim,  a  refined 
woman,  has  been  obliged  to  take  in  washing  for  a  living  on 
account  of  these  vampires.  I  know  of  a  case  where  a 
dying  man  put  all  he  had,  $10,000,  into  something  that  he 
thought  was  good,  one-half  to  go  to  his  son  and  the  other 
half  to  his  daughter,  and  now  there  is  nothing.  I  know  of 
still  another  case — and  all  these  cases  have  come  under  my 
personal  observation — where  stock  is  being  sold  at  $2  par 
value,  and  the  book  value  is  only  38  cents.  I  knew  a  real 
estate  manipulator,  with  his  property  mortgaged  to  the 
hilt — who  was  hard  up,  with  not  money  enough  to  pay  his 
taxes — who  formed  a  stock  company,  and  went  into  the 
business  of  selling  its  shares.  He  holds  control  of  the  com- 
pany, and  is  now  drawing  over  $10,000  a  month,  although 
its  expenses  are  more  than  the  income.  All  this  money 
comes  from  suckers  who  buy  the  stock. 

Getting  a  Credit  Standing 

Manipulators  of  this  kind  resort  to  an  infinite  variety 
of  schemes  to  further  their  semi-fraudulent  enterprises. 
A  banker  told  me  the  other  day  of  a  man  who  came  into 
his  bank  and  said,  "Mr.  Blank,  I  have  opened  an  account 
in  your  bank,  and  I  want  you  to  know  it."  "And,"  the 
banker  continued,  "every  time  that  man  came  in  afterwards 
with  a  deposit,  he  would  make  it  a  point  to  come  to  my 
desk,  in  order  to  show  that  he  had  an  active  account  in  the 
bank."  After  a  while  I  found  out  what  he  was  after,  for 
one  day  he  came  to  me  and  said,  "Mr.  Blank,  there  are 


I34  MERCANTILE  CREDITS 

inquiries  about  us  on  the  outside,  and  I  should  like  to  use 
your  bank's  name  as  a  reference."  I  said,  "Well,  I  have 
no  objections,  but  wouldn't  it  be  just  as  well  if  you  told  me 
something  about  yourself  and  your  concern  ?"  "Certainly. 
Do  you  know,"  he  said,  "that  the  proposition  in  which  I 
am  interested  is  going  to  be  the  biggest  industry  in  the 
world?"  And  he  explained  just  what  it  was,  but  the 
banker  knew  the  actual  facts,  and  told  his  depositor  flatly 
that  he  was  a  gold  brick  artist,  and  a  bunco  steerer;  and 
finally  added,  "You  refer  inquirers  to  us,  and  take  partic- 
ular care  to  see  that  the  correspondence  comes  to  me  per- 
sonally, and  I'll  tell  them."  But  the  depositor  did  not 
refer.  He  withdrew  his  account.  His  concern  spends 
perhaps  $15,000  a  year  of  stockholders'  money  in  adver- 
tising. 

Swindling  Schemes 

Some  of  the  schemes  encountered  in  the  course  of  an 
accountant's  investigations  are  nothing  more  nor  less  than 
swindles.  In  one  case  in  my  own  experience,  the  pro- 
moters of  a  land  company  wanted  to  get  a  good  lot  of 
stock  for  themselves  without  giving  any  real  quid  pro  quo. 
The  stock  was  selling  at  20  cents  a  share.  After  studying 
over  the  situation,  the  promoters  devised  the  following 
somewhat  ingenious  plan :  They  had  an  option  on  a  valu- 
able piece  of  land.  "Now,"  they  said,  "we  will  sell  that 
option  to  the  company  f  or  $  1 5 ,000 ;  that  is  to  say,  $  1 5 ,000 
worth  of  stock."  This,  at  20  cents  a  share,  mounted  up 
to  75,000  shares.  The  plan  was  carried  out.  The  com- 
pany bought  the  option,  and  the  promoters  got  their  75,- 
ooo  shares  of  stock,  which,  in  consequence  of  the  rise  in 
value  of  land  held  by  the  company,  is  now  worth  consid- 
erably more  than  20  cents  a  share.  The  company  never 
exercised  the  option.  Of  course,  that  was  the  company's 


AUDITS  AND  INVESTIGATIONS  135 

misfortune.  It  had  paid  stock  actually  worth  $15,000 
for  this  option  which  had  never  been  exercised. 

In  another  case  which  came  under  my  observation,  the 
swindle  was  even  more  lightly  disguised.  The  chemical 
formula  for  sugar  is  C12  HL  Ou.  The  formula  for  water  is 
H2  O.  Now,  a  very  shrewd  young  fellow  saw  the  formula 
for  sugar,  and  it  occurred  to  him  that  it  looked  like  carbon 
and  water.  So  he  devised  a  scheme  to  make  sugar,  not  out 
of  sugar  cane  or  beets,  but  out  of  water  and  carbon.  Ap- 
parently he  was  successful.  I  saw  him  make  the  sugar,  or 
thought  I  did,  and  I  have  some  of  it  now.  It  is  a  very 
fine,  pulverized  sugar.  The  bright  young  man  had  a  very 
elaborate  mechanism  which  transformed  the  water  into 
steam,  and  passed  this  steam  through  fine  tubes,  where  it 
was  gasified.  In  another  mechanism  he  was  burning  char- 
coal to  get  his  carbon,  and  these  things  were  mixed  and 
supposedly  combined  by  means  of  an  electrical  current. 

I  do  not  know  how  he  did  it,  but  after  a  while  the  mix- 
ture came  out  fine  powdered  sugar.  On  the  strength  of 
that  exhibit  he  sold  a  very  great  deal  of  stock.  Of  course, 
the  whole  thing  was  a  humbug;  and  the  last  I  heard  of  the 
bright  young  man  the  Pinkertons  were  looking  for  him. 


Now,  in  conclusion,  everything  that  I  have  said  may 
be  summed  up  in  this  one  piece  of  advice :  Always  insist 
upon  the  full  truth  when  you  are  asked  to  give  credit.  Get 
the  profit  and  loss  statement  as  well  as  the  statement  of 
assets  and  liabilities,  and  see  that  they  tell  everything  they 
should. 


CHAPTER  VIII 

LIENS  ON  PERSONAL  PROPERTY* 
BY  N.  P.  CONREY 

Fundamental  Property  Rights 

The  Constitution  of  the  United  States  guarantees  to 
all  of  us  the  fundamental  right  of  security  for  life,  liberty, 
and  property.  To  be  a  free  man  is  necessarily  to  be  one 
who  is  capable  of  holding,  owning,  and  controlling  prop- 
erty— things  of  value  for  personal  use,  of  value  to  society, 
and  therefore  things  which  are  articles  of  commerce. 
These  things  the  free  man  may  hold  in  his  own  right.  To 
the  extent  of  that  ownership  the  law  gives  him  an  attri- 
bute of  sovereignty.  The  state  itself  guarantees  that  it 
will  not  interfere  with  that  right  except  where  this  is 
necessary  for  the  public  good.  It  is  provided,  therefore, 
that  one's  property  shall  not  be  taken  away  without  due 
process  of  law;  and  that  it  shall  not  be  taken  away  under 
any  pretense,  against  the  owner's  will  until  after  the 
ascertainment  and  payment  to  him  of  due  compensation. 
So,  a  man  and  his  property  stand  encircled  and  protected 
by  the  law. 

Sale  and  Transfer 

Now,  that  is  good  for  a  starting  point,  but  no  one 
lives  to  himself  alone.  Man  is  a  social  being.  He  seeks 


*  It  is  impossible  to  give  the  varying  lien  laws  of  the  different  states  in  the  present 
volume.  The  California  law  which  is  discussed  here  will  give  a  fair  idea  of  the  general 
law  of  liens  and  will  indicate  what  the  credit  man  must  look  for  when  investigating  the 
matter  in  other  states. 


136 


LIENS  ON  PERSONAL  PROPERTY 


137 


social  relationships,  or  has  them  forced  upon  him.  He 
then  begins  to  have  also  legal  relationships,  and  his  prop- 
erty, too,  begins  to  have  legal  relationships  which  bring 
him  and  it  into  touch  with  other  members  of  society,  and 
this  leads  to  trade  and  transfer.  Out  of  affection  or 
philanthropy,  you  may  give  your  property  away;  you 
may  exchange  it  for  other  property  or  you  may  sell  it 
for  the  medium  of  exchange,  which  we  call  money. 
There  are  rules  of  law  and  practice  applicable  to  all  such 
transfers;  conveyance  of  land  by  deed  or  by  delivery  of 
possession;  conveyance  of  personal  property  by  delivery 
of  possession  and  bill  of  sale;  and  so  on. 

Liens 

Then  there  is  another  line  of  relationships  which 
comes  short  of  sale,  transfer,  or  conveyance  in  the  first 
instance;  and  these  relationships  are  described  by  the 
word  "lien."  This  word  implies  that  the  owner  of  the 
property  continues  to  be  the  owner;  but  someone  else, 
who  is  described  as  the  holder  of  the  lien,  has  acquired 
a  claim  upon  that  property — not  a  claim  of  ownership, 
but  a  claim  of  right  to  hold  that  property  as  a  pledge,  or 
security  for  the  performance  of  an  obligation  which  has 
been  personally  contracted  towards  him,  or  which  is  im- 
posed because  of  some  service  rendered  with  relation  to 
the  property. 

The  Civil  Code 

In  California  we  have  a  set  of  written  laws  which  we 
call  the  Civil  Code.  We  have  also  a  Penal  Code,  a  Code 
of  Civil  Procedure,  a  Political  Code,  and  the  general 
statutes  of  the  state.  But  the  Civil  Code  is  the  body  of 
statute  law  in  which  the  state  sets  forth  especially  the 
laws  relating  to  property,  legal  contracts  and  obligations, 


138  MERCANTILE  CREDITS 

and  so  on.  This  Code  is  simply  an  expression  in  statu- 
tory form  of  the  principles  of  the  common  law,  modified 
by  new  declarations  of  the  will  of  the  state;  it  includes 
in  statutory  form  those  instances  where  the  legislators  of 
the  state  were  not  satisfied  with  the  common  law  as  it 
stood. 

Origin  of  the  Common  Law 

In  your  general  reading  you  will  often  find  a  dis- 
tinction made  between  civil  and  common  law,  and  per- 
haps some  of  my  readers  who  are  not  students  of  law 
will  follow  me  more  easily  if  I  explain  first  what  is  meant 
by  "Common  Law."  The  states  of  Europe  are  largely 
controlled  by  systems  of  law  derived  or  copied  from  the 
Corpus  Juris  Civilis,  or  Code  of  Civil  Law  of  the  Roman 
Empire — that  great  law-giving  nation  of  the  ancient 
world — and  many  principles  of  the  Roman  civil  law  have 
directly  or  indirectly  found  lodgment  in  our  own  system. 
But  apart  from  the  Roman  law  which  prevailed  in 
Europe,  there  grew  up  in  England  a  characteristic- Eng- 
lish law  which  was  not  the  outgrowth  of  centuries  of 
learning  embodied  in  books  and  formally  stated  by 
jurists,  but  the  practical  outgrowth  or  development  of 
the  experience  of  the  English  people  and  of  their  courts 
and  judges.  In  this  way  they  built  up  gradually  a  system 
of  law,  or  rather,  a  congeries  of  laws,  a  hodge-podge  of 
laws,  if  you  please.  Nevertheless,  when,  in  the  course  of 
time,  men  reduced  it  to  a  more  formal  system,  it  proved 
to  be,  as  Blackstone  has  pointed  out,  a  beautiful  system 
of  laws,  expressive  of  the  rights,  duties,  and  obligations 
of  men  to  each  other  and  to  society.  The  founders  of 
the  thirteen  colonies  brought  with  them  the  common  law 
of  the  mother  country,  and  their  descendants  carried  it 
into  the  West  and  South,  so  that  today  nearly  all  the 


LIENS  ON  PERSONAL  PROPERTY  139 

states  of  the  Union  have,  for  the  basis  of  their  jurispru- 
dence, the  English  common  law  as  it  stood  at  the  time  of 
the  War  of  Independence.  When  California  was  ad- 
mitted, in  1850,  the  question  came  up  as  to  whether  we 
should  adopt  the  civil  law  which  prevailed  in  Mexico — 
to  which  California  had  formerly  belonged — or  the  Eng- 
lish common  law.  The  commission  appointed  to  study 
the  question  recommended  that  the  common  law  of  Eng- 
land, as  followed  in  the  Eastern  states,  should  be  the 
basis  of  our  law.  Later,  when  it  became  desirable  to 
codify  the  laws  of  the  state,  the  codes  which  I  have  named 
were  formulated,  among  them  being  the  Civil  Code, 
which  is  expressive,  in  large  degree,  of  the  principles  of 
the  common  law  as  they  are  found  in  the  old  records  and 
decisions  of  the  common  law  courts. 

The  Object  of  Legislation 

It  has  been  said  that  law  is  the  perfection  of  reason. 
Of  course,  that  was  said  by  an  admirer  of  the  law;  but 
the  law,  like  every  other  human  institution,  has  its  de- 
fects. The  object  of  the  law  is  to  promote  justice  by 
compelling  men  to  perform  their  just  obligations  to  each 
other  and  to  the  state;  yet  we  frequently  hear  of  the  in- 
justice of  laws.  The  legislature  may  adopt  a  law  that  is 
oppressive  to  some  one,  or  that  fails  to  bring  about  the 
expected  good  result;  and  it  may  be  that  the  courts,  in 
endeavoring  to  apply  that  law  as  they,  after  study,  think 
they  understand  it,  may  fail  of  perfect  results  as  regards 
the  administration  of  justice;  but  we  have  nevertheless 
developed  in  this  country  a  system  of  approximate  jus- 
tice, a  pretty  good  article  of  human  justice,  under  which 
men  may,  except  perhaps  under  the  stress  of  public  excite- 
ment or  other  unusual  circumstances,  live  peaceably  and 
transact  business  with  each  other. 


140  MERCANTILE  CREDITS 

The  Law  of  Liens 

We  come  now  to  the  definition  of  lien  as  expressed  in 
the  Code.  "A  lien  is  a  charge  imposed  upon  specific 
property,  by  which  it  is  made  security  for  the  perform- 
ance of  an  act,  and  it  is  created  either  by  contract  of  the 
parties,  or  by  operation  of  law."  In  order  that  you  may 
get  the  general  meaning  clearly,  I  have  omitted  a  qualify- 
ing clause  in  that  definition,  which,  in  full,  reads  as 
follows:  "A  lien  is  a  charge  imposed,  in  some  mode  other 
than  by  a  transfer  in  trust,  upon  specific  property,  by 
which  it  is  made  security  for  the  performance  of  an  act." 
Now,  I  think  we  have  the  idea  of  the  lien.  It  is  the  legal 
right  of  the  creditor  to  compel  the  property  to  answer 
for  an  obligation.  As  a  general  term  the  word  lien 
applies  equally  to  real  property  and  to  personal  property. 

Priority  of  Liens  According  to  Date 

There  may  be  several  liens  upon  the  same  thing.  You 
have  heard  of  a  first  mortgage,  a  second  mortgage,  and 
a  third  mortgage;  and  in  the  same  way  there  may  be 
several  liens  upon  the  same  personal  property,  the  same 
household  goods,  or  the  same  stock  of  merchandise.  The 
element  of  time  is  important  in  determining  the  order, 
value,  or  priority,  of  liens;  and  we  have  this  rule,  that 
(there  being  no  reason  to  the  contrary)  liens  on  the  same 
property  have  priority  according  to  their  dates. 

Bottomry  Liens 

Now,  there  is  an  exception  to  this  rule  which  we  will 
dispose  of  in  a  few  words,  as  it  is  of  interest  to  a  com- 
paratively small  number  of  business  men.  This  exception 
refers  to  cases  of  bottomry  and  respondentia  liens,  respect- 
ively obtained  on  ships  and  their  cargoes,  where  the  risk  is 
of  a  maritime  character.  Bottomry  is  a  contract  by  which 


LIENS  ON   PERSONAL  PROPERTY  141 

a  ship  or  its  freightage  is  hypothecated  as  a  security 
for  a  loan,  which  is  to  be  repaid  only  in  case  the  ship  sur- 
vives a  particular  risk,  voyage,  or  period.  In  the  case  of 
two  or  more  bottomry  liens  on  the  same  subject,  a  later 
one  would  have  the  priority  if  created  out  of  necessity. 
For  instance,  it  may  be  that  the  cargo  is  about  to  go  to 
the  bottom  of  the  sea,  or  its  owner  finds  himself  in  some 
other  difficulty  in  connection  with  the  safety  of  the  ship, 
or  cargo,  or  with  the  successful  result  of  the  voyage. 
Now,  the  loan  which  enables  the  merchant  to  save  his 
ship  or  cargo  from  these  perils,  or  enables  him  to  reach 
his  market,  will  have  preference  over  any  other  because 
of  its  peculiar  relation  to  the  thing  taken  as  security,  even 
though  other  liens  had  the  priority  in  point  of  time.  With 
the  exception  of  these  special  instances,  however,  different 
liens  on  the  same  property  have  priority  according  to  the 
time  of  their  creation. 

Distinction  between  the  Pledge  and  the  Mortgage 

The  matter  of  possession  distinguishes  two  classes  of 
liens:  (i)  where  the  owner  remains  in  possession,  and 
(2)  where  the  owner  goes  out  of  possession.  In  the 
case  of  a  pledge,  the  property  is  put  in  possession  of  the 
pledgee,  the  creditor,  or  a  pledge  holder.  In  the  case  of 
a  mortgage,  the  property  is  retained  in  possession  by  the 
owner,  but  the  creditor  receives  in  some  legal  form,  a 
paper  lien — a  thing  of  the  mind,  of  the  law.  It  enables 
him  to  compel  payment  of  the  debt,  however,  just  the 
same  as  if  he  held  the  property  pledged.  In  conditional 
sales  or  transfers  of  property  the  vendor  has  something 
more  than  a  lien;  he  actually  retains  the  legal  ownership, 
after  the  possession  of  the  property  passes  into  the  hands 
of  the  debtor-purchaser,  and  he  may,  on  the  failure  of  the 
purchaser  to  keep  his  contract,  recover  actual  possession. 


142  MERCANTILE  CREDITS 

Formalities  of  a  Mortgage 

A  mortgage  can  be  created,  renewed,  or  extended 
only  by  a  written  contract  executed  with  the  formalities 
required  in  the  case  of  a  grant  of  real  property.  That  is 
to  say,  a  mortgage  must  be  acknowledged  before  a  notary 
public  in  order  to  be  recorded  and  to  have  all  the  rights 
that  it  should  have.  The  mortgage  of  personal  property 
requires  further  formalities,  in  the  form  of  affidavits,  as 
explained  later. 

The  Mortgagor  is  the  Owner 

The  mortgagor  of  property  is  the  owner  and  remains 
in  possession.  He  has  simply  made  a  contract  imposing 
a  lien  on  his  property,  but  which  does  not  result  in  any 
transfer  of  ownership  except  in  case  of  foreclosure  and 
sale.  "Every  transfer  of  an  interest  in  property  (other 
than  in  trust)  made  only  as  security  for  the  performance 
of  any  other  act,  is  to  be  deemed  a  mortgage,  except 
when,  in  the  case  of  personal  property,  it  is  accompanied 
by  actual  change  of  possession,  in  which  case  it  is  to  be 
deemed  a  pledge."  This  definition  again  very  clearly 
emphasizes  the  difference  as  to  possession  between  a 
mortgage  and  a  pledge. 

Legal  Effect  of  a  Mortgage 

A  mortgage  does  not  bind  the  mortgagor  personally 
to  perform  the  act  for  the  performance  of  which  it  is 
security,  unless  there  is  an  express  covenant  to  that  effect. 
A  mortgage  may  be  made  by  the  owner  of  property  as 
security  for  the  payment  of  another  man's  debt.  In  that 
event,  unless  the  mortgage  specifically  provides,  or  the 
mortgagor  in  some  other  way  has  specifically  provided 
or  made  an  express  covenant  that  he  will  pay,  he  has 
simply  handed  over  his  property  to  be  subject  to  the  lien. 


LIENS  ON  PERSONAL  PROPERTY  143 

A  power  of  sale  may  be  conferred  by  a  mortgage  upon 
the  mortgagee,  or  any  other  person,  to  be  exercised  after 
a  breach  of  the  obligation  for  which  the  mortgage  is  a 
security. 

Assignment  of  Claim 

The  assignment  of  a  claim  secured  by  mortgage  car- 
ries the  security  with  it.  For  example,  here  is  a  note, 
secured  by  a  mortgage  upon  land  or  personal  property. 
The  assignment  of  the  note  carries  with  it  the  security. 
The  custom  is,  very  properly,  to  assign  the  mortgage 
with  the  note,  and  to  record  the  assignment.  But  the 
rule  remains  the  same,  that  the  mortgage  is  an  incident 
to  the  debt,  and  whoever  owns  the  debt  has  the  right  to 
the  mortgage. 

The  Law  of  Chattel  Mortgages 

Now  we  come  to  mortgages  on  personal  property.  A 
section  of  the  Civil  Code  of  California,  adopted  in  1872, 
provided  specifically  a  short  list  of  articles  of  personal 
property  on  which  chattel  mortgages  might  be  made,  and 
you  could  not  put  a  chattel  mortgage  on  personal  prop- 
erty, except  as  the  Code  provided.  This  list  was  gradu- 
ally extended.  The  needs  of  business  called  for  more 
liberality;  and  it  became  the  regular  biennial  custom  to 
amend  Section  2955  of  the  Civil  Code,  describing  articles 
of  personal  property  that  might  be  mortgaged.  These 
amendments  began  in  1875  and  extended  on,  about  every 
two  years,  until  1907.  By  this  time  the  legislators  had 
become  conscious  of  the  absurdity  of  a  long  list  of  this 
kind,  and  they  therefore  reversed  their  method,  and  by 
the  amendment  of  1909  made  the  general  rule  that  such 
mortgages  may  be  placed  on  all  kinds  of  personal  prop- 
erty, with  three  exceptions.  The  amendment  of  1909 
reads  simply:  "Mortgages  may  be  made  upon  all  grow- 


I44  MERCANTILE  CREDITS 

ing  crops,  including  grapes  and  fruit,  and  upon  any  and 
all  kinds  of  personal  property,  except  the  following:  per- 
sonal property  not  capable  of  manual  delivery;  articles  of 
wearing  apparel  and  personal  adornment;  the  stock  in 
trade  of  a  merchant." 

Executing  a  Chattel  Mortgage 

We  come  now  to  the  formal  steps  in  executing  a 
chattel  mortgage,  as  to  acknowledgment  and  affidavit.  A 
mortgage  of  personal  property  is  void  as  against  credi- 
tors of  the  mortgagor,  and  subsequent  purchasers  and 
encumbrancers  of  the  property  in  good  faith  and  for 
value,  unless  it  is  accompanied  by  the  affidavit  of  all  the 
parties  thereto,  both  debtor  and  creditor,  that  it  is  made 
in  good  faith  and  without  any  design  to  hinder,  delay,  or 
defraud  creditors;  there  must  be  also  an  acknowledgment 
and  certificate,  as  in  case  of  grants  of  real  property.  It 
requires  two  kinds  of  certificates — one  of  acknowledg- 
ment and  one  of  oath.  Now  note  again  that  there  are 
several  persons  who  may  claim  exemption;  that  is,  who 
may  claim  not  to  be  bound  by  the  mortgage  unless  it  is 
in  this  form.  In  the  first  place  there  are  the  creditors  of 
the  mortgagor;  that  is,  any  creditor  other  than  the  mort- 
gagee, who  may  be  seeking  to  find  the  property  of  this 
mortgagor  and  bind  it  by  some  process  of  law  to  compel 
the  payment  of  debts.  Or,  suppose  the  man  who  has 
made  or  attempted  to  make  the  mortgage,  has  made  no 
such  affidavit,  and  subsequently  sells  the  property.  The 
mortgage  would  be  void  as  to  any  subsequent  purchaser 
in  good  faith  and  for  value,  or  as  to  any  subsequent 
mortgagee.  Thus  great  care  must  be  exercised  with  re- 
gard to  the  form  of  the  mortgage,  and  especially  in  re- 
quiring the  affidavit  of  both  parties,  in  addition  to  the 
duly  certified  acknowledgment. 


LIENS  ON   PERSONAL  PROPERTY  145 

Recording  Chattel  Mortgages 

A  mortgage  of  personal  property  must  be  recorded 
in  the  office  of  the  county  recorder  of  the  county  in  which 
the  mortgagor  resides,  if  the  mortgagor  be  a  resident  of 
the  state,  and  it  must  also  be  recorded  in  the  county  in 
which  the  property  mortgaged  is  situated,  or  to  which  it 
may  be  removed.  I  remember  a  case  a  short  time  ago 
where  the  mortgaged  property  was  in  Los  Angeles 
County,  and  the  mortgagor  resided  in  Riverside  County. 
The  claim  was  set  up  on  behalf  of  some  third  person  that, 
although  this  mortgage  was  in  due  form,  and  had  been 
duly  recorded  in  Los  Angeles  County,  it  had  not  been 
recorded  in  Riverside  County  where  the  mortgagor  re- 
sided, and  therefore  the  mortgage  was  not  good,  and  a 
third  party  might  buy  the  property  and  get  rid  of  it.  But 
in  that  case  the  mortgage  prevailed,  even  though  the 
technical  requirements  of  the  law  had  not  been  complied 
with.  But  this  decision  was  owing  to  some  special  rela- 
tion of  the  parties  which  made  it  inequitable  to  enforce 
the  general  rule. 

Removal  of  Mortgaged  Property 

Again,  when  personal  property  mortgaged  is  there- 
after by  the  mortgagor  removed  from  the  county  in  which 
it  is  situated,  it  is,  except  as  between  the  parties  to  the 
mortgage,  exempted  from  the  operation  thereof.  The 
man  who  mortgages  his  personal  property  has  not  the 
right  to  move  it  out  of  the  county  without  complying  with 
certain  rules;  but  if  he  does,  the  mortgage  is  no  longer 
good  except  between  the  parties  who  made  it,  unless  the 
mortgagee  within  thirty  days  after  such  removal  causes 
it  to  be  recorded  in  the  county  to  which  the  property  was 
removed,  or  else,  within  thirty  days  after  such  removal, 


I46  MERCANTILE  CREDITS 

himself  takes  possession  of  the  property.  It  is  provided 
that,  if  the  mortgagor  voluntarily  removes  or  permits  the 
removal  of  the  mortgaged  property  from  the  county  in 
which  it  was  situated  when  mortgaged,  the  mortgagee 
may  take  possession  and  dispose  of  the  property  as  a 
pledge  for  payment  of  the  debt,  even  though  the  debt  is 
not  due. 

Penalty  for  Unlawful  Removal 

Under  Section  538  of  the  Penal  Code,  mortgagors  of 
personal  property,  excepting  certain  property  used  in 
transportation  business,  are  forbidden,  without  the 
written  consent  of  the  mortgagee,  to  remove  the  mort- 
gaged property,  or  to  cause  or  permit  it  to  be  removed, 
with  intent  to  defraud  the  mortgagee,  or  his  representa- 
tives and  assigns,  from  the  county  where  it  was  situated 
when  mortgaged,  and  they  are  likewise  forbidden  to  en- 
cumber such  property,  or  cause  it  to  be  sold,  transferred, 
or  further  encumbered.  And  the  mortgagor  for  violation 
of  this  law  is  made  guilty  of  larceny,  and  is  punishable 
accordingly,  unless  at  or  before  the  time  of  doing  any  of 
the  acts  referred  to,  the  mortgagor  informs  the  person 
to  whom  he  makes  sale,  transfer,  or  encumbrance,  of  the 
existence  of  the  prior  mortgage,  and  also  informs  the 
prior  mortgagee  in  writing  of  the  intended  sale,  transfer, 
or  encumbrance,  by  giving  the  name  and  place  of  resi- 
dence of  the  person  to  whom  the  sale,  transfer,  or  encum- 
brance is  to  be  made. 

I  find  in  the  reports  of  the  Supreme  Court  and  Appel- 
late Courts  of  this  state  just  one  case  where  a  man  was 
convicted  under  that  section.  The  conviction  was  affirmed, 
and  I  presume  he  has  had  to  suffer  imprisonment.  His 
offense  was  the  selling  of  a  one-fifth  interest  in  the 
furniture  of  a  lodging  house  without  notifying  the  pur- 
chaser of  the  existence  of  a  chattel  mortgage. 


LIENS  ON  PERSONAL  PROPERTY  147 

Validity  of  Contracts  Made  in  Good  Faith 

Mortgages  of  personal  property,  other  than  those 
permitted  under  Section  2955,  and  mortgages  not  made 
in  conformity  with  the  provisions  of  this  article,  or  por- 
tion of  the  Code  just  discussed,  are  nevertheless  valid 
between  the  parties,  their  heirs,  legatees,  and  personal 
representatives,  and  persons  who,  before  parting  with 
value,  have  actual  notice  thereof.  In  other  words,  these 
provisions  are  for  the  protection  of  innocent  parties,  not 
for  the  protection  of  rogues  who  would,  if  permitted, 
repudiate  their  obligations  because  they  had  not  been  put 
in  legal  form. 

The  Law  of  Pledges 

Now  we  will  pass  from  mortgages  to  pledges.  A 
pledge  is  a  deposit  of  personal  property  by  way  of  secur- 
ity for  the  performance  of  another  act.  The  Code  Com- 
missioners call  attention  in  a  note  to  this  section  of  the 
Code,  to  something  that  I  have  already  mentioned.  They 
state  that  much  difficulty  has  arisen  in  determining 
whether  a  certain  transaction  is  a  pledge  or  a  chattel 
mortgage,  the  question  generally  being  whether  or  not  the 
title  has  passed.  In  this  state,  title  never  passes  in  case 
of  property  mortgaged  or  deposited  as  security;  and 
whenever  the  possession  of  personal  property  is  trans- 
ferred as  security  only,  it  is  to  be  treated  as  a  pledge. 
Even  a  chattel  mortgage,  when  the  possession  of  the 
property  mortgaged  is  transferred,  becomes  a  pledge. 
Possession  is  the  criterion.  Every  contract  by  which  the 
possession  of  personal  property  is  transferred  as  security 
only,  is  deemed  to  be  a  pledge.  The  lien  of  a  pledge  is 
dependent  on  possession.  Now  notice  that  difference.  A 
mortgage,  or  the  lien  of  a  mortgage,  is  not  dependent  on 
possession.  Its  security  is  obtained,  not  by  taking  the 


148  MERCANTILE  CREDITS 

thing,  but  by  taking  the  paper  which  refers  to  it  and 
describes  it,  and  recording  that  paper  in  some  place 
designated  by  the  law  for  public  notices.  The  lien  of  a 
pledge  is  dependent  on  possession,  and  no  pledge  is  valid 
until  the  property  pledged  is  delivered  to  the  pledgee,  or 
to  a  pledge  holder. 

One  who  has  a  lien  on  property  may  pledge  it  to  a 
third  person  to  the  extent  of  his  lien.  For  example,  A 
is  a  creditor  of  B;  A  has  a  lien  upon  B's  property — he 
may  have  his  horse  or  his  cow  in  his  possession  as  a 
pledge.  A  needs  money;  he  wants  credit  somewhere.  He 
may  pledge  that  horse,  or  that  cow,  to  C  to  the  extent  of 
his  lien,  that  is,  to  the  extent  of  the  debt  already  secured 
thereby. 

Re-pledging  of  Property 

"One  who  has  allowed  another  to  assume  the  appar- 
ent ownership  of  property  for  the  purpose  of  making  any 
transfer  of  it,  cannot  set  up  his  own  title  to  defeat  a 
pledge  of  the  property,  made  by  the  other,  to  a  pledgee 
who  received  the  property  in  good  faith,  in  the  ordinary 
course  of  business,  and  for  value."  (Civil  Code,  Section 
2991.)  This  refers  to  another  relation  that  may  exist 
between  persons  in  regard  to  property.  You  put  your 
property  in  the  hands  of  another  person,  allowing  him  to 
assume  the  apparent  ownership  of  it;  and  you  do  that  for 
the  very  purpose  of  enabling  him  to  sell  it;  but  instead 
of  selling  it,  he  pledges  it.  That  is  the  situation  already 
described,  and  the  pledge  is  good  provided  the  pledgee 
has  acted  in  good  faith. 

The  Pledge  Holder 

A  pledger  and  pledgee  may  agree  upon  a  third  person 
with  whom  to  deposit  the  property  pledged,  who,  if  he 


LIENS  ON  PERSONAL  PROPERTY     149 

accepts  the  deposit,  is  called  the  pledge  holder.  There 
are  certain  rules  regarding  the  duties  of  a  pledge  holder, 
but  these  details  may  be  omitted  here. 

Misrepresenting  Value  of  Pledge 

Where  a  debtor  has  obtained  credit,  or  an  extension 
of  time,  by  a  fraudulent  misrepresentation  of  the  value  of 
the  property  pledged  by  or  for  him,  the  creditor  may  de- 
mand a  further  pledge  to  correspond  with  the  value  rep- 
resented, and,  in  default  thereof,  may  recover  his  debt 
immediately,  though  it  be  not  actually  due.  That,  of 
course,  is  just.  A  man  borrows  money  on  90  days,  or  has 
purchased  goods  on  90  days'  time,  and  he  has  pledged 
something  which  he  represented  to  be  worth  the  amount 
of  the  debt,  or  90  per  cent  of  it,  or  whatever  is  required, 
and  his  word  is  taken  without  investigation;  but  it  turns 
out  the  next  week  that  he  has  pledged  property  that  is 
practically  worthless,  or  is  worth  only  5  per  cent  of  the 
pledge;  in  other  words,  the  creditor  has  been  imposed  on. 
What  shall  he  do?  He  has  given  90  days'  credit.  The 
law  says  that  the  implied  obligation  to  wait  90  days  is 
cancelled  by  reason  of  the  fraud,  and  the  creditor  may  act 
at  once,  and  say,  "You  must  make  good  your  promise  as 
to  the  value  of  this  pledge;  you  must  give  me  other 
security  equal  to  the  value  that  you  represented  in  this 
case;  and  if  you  don't  do  that,  I  will  proceed  immediately 
by  legal  means  to  collect  upon  that  debt,  just  as  if  the 
contract  had  read,  'I  promise  to  pay  on  demand.' ' 

Sale  of  Pledged  Property 

Some  of  you  may  like  to  know  the  precise  rules  cover- 
ing sales  and  pledges;  and  the  shortest  and  most  accurate 
way  is  simply  to  read  the  written  law.  "When  per- 
formance of  the  act  for  which  a  pledge  is  given,  is  due, 


1 5o  MERCANTILE  CREDITS 

in  whole  or  in  part,  the  pledgee  may  collect  what  is  due 
to  him  by  a  sale  of  the  property  pledged." 

But  before  pledged  property  can  be  sold  and  after  the 
performance  of  the  act  for  which  it  is  security,  is  due, 
what  must  the  pledgee  do  ?  He  must  demand  perform- 
ance from  the  debtor  if  the  debtor  can  be  found.  What 
we  call  "snap  judgment"  is  not  permitted  in  law,  even 
though  the  debtor  is  delinquent,  and  has  failed  to  keep 
his  promises.  If,  however,  the  pledgee  has  made  his  de- 
mand for  performance,  and  still  the  debtor  does  not  pay, 
the  pledgee  has  complied  with  the  requirements  of  the  law 
as  to  demand,  and  may  realize  upon  the  pledge  by  selling 
it  if  he  will.  First,  though,  the  pledgee  must  give  actual 
notice  to  the  pledger  of  the  time  and  place  at  which  the 
property  pledged  will  be  sold,  at  such  reasonable  time 
before  the  sale  as  will  enable  the  pledger  to  attend.  This 
is  very  important  and  necessary,  because  in  sales  of  per- 
sonal property  there  is  no  subsequent  right  of  redemption 
as  there  is  in  the  case  of  a  mortgage. 

Notice  May  be  Waived 

Notice  of  sale  may,  however,  be  waived  by  a  pledger 
at  any  time,  but  is  not  waived  by  a  mere  waiver  of  de- 
mand of  performance.  I  have  shown  you  how  the 
pledgor  is  entitled  to  a  demand  of  performance  before  a 
sale,  and  he  is  also  entitled  to  a  notice  separate  from  the 
demand  of  performance,  though  they  may  both  be  made 
at  the  same  time,  or  very  close  together.  A  debtor  or 
pledgor  may  also  waive  a  demand  of  performance  as  a 
condition  precedent  to  a  sale,  by  a  positive  refusal  to  per- 
form after  performance  is  due.  That  is  clear  enough,  I 
suppose.  He  has  the  right  to  demand  notice  before  sale ; 
but  if  he  says  to  the  creditor,  "I  will  not  pay;  I'm  through 
with  you ;  I  don't  intend  to  pay,"  he  has  made  a  positive 


LIENS  ON  PERSONAL  PROPERTY          151 

refusal,  and  no  formal  demand  of  performance  is  neces- 
sary on  the  part  of  the  creditor. 

Manner  of  Selling  Pledged  Property 

Now  as  to  the  manner  of  sale  of  pledged  property. 
The  sale  by  pledgee  of  pledged  property  must  be  made  by 
public  auction  in  the  same  manner,  and  with  the  same 
formalities,  as  provided  in  the  Code  for  the  sale  of  per- 
sonal property  under  execution.  The  pledgee  cannot, 
however,  sell  any  evidence  of  debt  pledged  to  him,  except 
where  he  holds  the  obligations  of  government,  states,  or 
corporations  in  pledge.  Those  he  can  sell;  but  in  any 
other  case,  he  simply  may  collect  them  when  due.  There 
are  also  legal  provisions  for  the  payment  of  the  surplus, 
if  any,  to  the  pledger  after  satisfaction  of  the  debt.  In- 
stead of  selling  property  pledged,  under  simple  notice  of 
sale,  without  going  into  court,  the  pledgee  may  go  into 
court  and  sue  on  his  claim  and  obtain  a  decree  of  sale, 
thereby  foreclosing  the  right  of  redemption.  After  this 
the  procedure  is  the  same  as  in  the  case  of  a  mortgage 
foreclosure  sale. 

Special  Lien  of  the  Vendor 

"One  who  sells  personal  property  has  a  special  lien 
thereon,  dependent  on  possession,  for  its  price,  if  it  is  in 
his  possession  when  the  price  becomes  payable;  and  he 
may  enforce  his  lien  in  like  manner  as  if  the  property  was 
pledged  to  him  for  the  price." 

Labor  Liens 

Now  as  to  special  liens  on  personal  property.  Sec- 
tion 305 1  of  the  Code  provides  a  lien,  dependent  on  pos- 
session, for  compensation  for  services  rendered  by  labor 
or  skill  employed  on  personal  property.  I  called  your 


1 52  MERCANTILE  CREDITS 

attention  in  the  beginning  to  the  fact  that  liens  are  granted 
in  two  ways :  one  by  contract,  and  the  other  by  operation 
of  law.  The  mortgage  and  pledge  liens  that  I  have  dis- 
cussed so  far  have  been  practically  all  liens  by  contract.  I 
think  that  what  I  am  about  to  quote  will  furnish  an  illus- 
tration of  liens  by  operation  of  law.  "Every  person  who, 
while  lawfully  in  possession  of  an  article  of  personal 
property,  renders  any  service  to  the  owner  thereof,  by 
labor  or  skill  employed  for  the  protection,  improvement, 
safe  keeping,  or  carriage  thereof,  has  a  special  lien 
thereon,  dependent  on  possession,  for  the  compensation, 
if  any,  which  is  due  to  him  from  the  owner  for  such 
service.  A  person  who  makes,  alters,  or  repairs  any 
article  of  personal  property  at  the  request  of  the  owner, 
and  has  legal  possession  of  the  property,  has  a  lien  on  the 
same  for  his  reasonable  charges  for  work  done  and  ma- 
terials furnished,  and  may  retain  possession  of  the  same 
until  the  charges  are  paid."  In  this  case  the  liens  are  by 
operation  of  law.  Not  that  there  has  been  an  agreement 
that  the  property  shall  remain  there  subject  to  the  pledge, 
but  simply  from  the  relation  formed  between  the  parties 
on  account  of  this  work  done.  The  pledgee  must  have 
possession,  and  is  entitled  to  hold  it  until  paid  for  his 
services.  "Livery  or  boarding  or  feed  stable  proprietors, 
and  persons  pasturing  horses  or  stock,  have  a  lien,  de- 
pendent on  possession."  And  parties  conducting  a  laundry 
business  have  also  a  lien,  depending  on  possession.  I  sup- 
pose many  an  impecunious  young  fellow  has  found  that 
out  to  his  sorrow.  Veterinary  proprietors,  and  veterinary 
surgeons  also,  and  others  giving  medical  treatment  to  ani- 
mals, and  keepers  of  garages,  all  have  liens  depending  on 
possession.  Special  rules  govern  the  sale  of  property 
where  the  lien  is  imposed  by  law,  and  such  rules  should 
receive  careful  scrutiny. 


LIENS  ON  PERSONAL  PROPERTY          153 

Bankers'  Liens 

Here  is  the  general  provision  with  regard  to  bankers' 
liens :  "A  banker  has  a  general  lien,  dependent  upon  pos- 
session, upon  all  property  in  his  hands  belonging  to  a 
customer,  for  the  balance  due  to  him  from  such  customer 
in  the  course  of  their  business."  The  relations  between 
a  banker  and  his  customers  are  evidently  very  friendly,  as 
I  find  but  one  decision  in  the  entire  legal  history  of  Cali- 
fornia down  to  date,  where  Section  3054  is  mentioned, 
and  that  was  merely  a  mention  of  its  existence.  I  suppose 
that  the  banks  are  able  to  enforce  their  liens  without 
much  application  to  the  courts.  But  it  is  worth  while  to 
note  the  general  provision. 

Warehouse  Receipts 

Credit  men  occasionally  have  to  do  with  warehouse 
receipts.  Warehouse  receipts  are  of  two  classes:  first, 
transferable  or  negotiable;  second,  non-transferable  or 
non-negotiable.  Under  the  first  of  these  classes  the  prop- 
erty is  transferable  by  indorsement  of  the  party  to  whose 
order  such  receipt  was  issued,  and  such  indorsement  is  a 
valid  transfer  of  the  property  represented  by  the  receipt, 
and  may  be  in  blank  or  to  the  order  of  another. 

If  a  non-negotiable  receipt  is  issued  for  any  property, 
neither  the  person  issuing  it,  nor  any  other  person  into 
whose  care  or  control  the  property  comes,  must  deliver 
any  part  thereof,  except  upon  the  written  order  of  the 
person  to  whom  the  receipt  was  issued. 

Necessity  of  Expert  Advice 

In  the  present  chapter  I  have  tried  to  cover — at  least 
in  its  main  outlines — the  subject  of  liens  on  personal 
property.  One  could,  however,  spend  months  on  the  sub- 
ject if  he  attempted  to  examine  all  the  situations  that  may 


MERCANTILE  CREDITS 

arise,  and  the  multitude  of  illustrations  that  do  arise  in 
actual  experience.  There  are  extensive  text  books  de- 
voted entirely  to  liens  on  personal  property.  But  this 
discussion  is  intended  for  the  student  of  business,  not  of 
law;  and  one  of  the  first  things  a  business  man  needs  to 
know  is  that,  when  a  real  difficulty  arises  outside  of  gen- 
eral business  transactions,  expert  counsel  from  a  compe- 
tent lawyer  is  the  only  safe  thing.  There  is  a  maxim  that 
a  lawyer  who  attends  to  his  own  case  has  a  fool  for  a 
client;  and,  if  this  is  so,  what  might  be  said  of  a  layman 
who  attempts  to  act  as  his  own  lawyer. 

Conditional  Sales 

We  will  conclude  with  the  subject  of  conditional  sales. 
It  is  a  general  principle,  as  I  have  tried  to  indicate,  that 
ownership  goes  with  possession,  and  a  person  in  posses- 
sion of  property  is  presumably  the  owner.  He  may,  how- 
ever, hold  that  property  in  pledge,  which  condition  gives 
him  something  in  the  nature  of  property  rights.  Analo- 
gous to  this,  it  is  sometimes  found  expedient  in  the  con- 
duct of  business  to  change  possession  of  property  by  way 
of  sale  without  passing  the  title  from  the  vendor.  This 
is  called  a  conditional  sale,  and  avoids  the  necessity  of 
passing  the  title  to  the  purchaser  and  taking  in  exchange 
a  chattel  mortgage  with  all  its  formalities  and  records. 
This  is  done  in  those  cases  where  the  purchaser  wants  to 
use  a  certain  thing,  and  is  not  ready  to  pay  for  it  and  at 
the  same  time  does  not  want  to  take  the  title  and  have  a 
recorded  chattel  mortgage.  In  such  cases  the  common 
law  permits  a  contract  of  conditional  sale.  Statute  laws 
in  some  states  have  tried  to  prohibit  such  sales;  but  in 
other  states — Massachusetts  being  a  notable  instance — 
their  usefulness  has  been  recognized,  and  the  legislature 
has  merely  attempted  to  regulate  them  by  making  rules 


LIENS  ON  PERSONAL  PROPERTY          155 

for  the  protection  of  the  public,  and,  at  the  same  time, 
for  the  protection  of  the  vendor  and  vendee.  One  of 
these  rules  is  that  the  person  who  wishes,  after  selling 
property  under  a  conditional  sale,  to  take  the  property 
back  for  non-payment,  must  make  a  formal  demand  and 
give  thirty  days'  notice.  The  experience  of  merchants  in 
Massachusetts  has  been  that  this  method  works  very  well, 
because  usually  satisfactory  arrangements  are  made  by 
the  debtor  within  the  thirty  days. 

Rights  of  Possession 

Under  ordinary  conditions,  a  person  in  possession  of 
personal  property  can  claim  to  be  the  owner  thereof — is, 
in  fact,  the  owner — and  transfer  by  him  is  accepted  as 
passing  the  title.  This  is  a  statement  of  customary  fact 
and  not  of  law,  for  it  is  possible  that  the  person  thus 
assuming  to  act  as  owner  may  have  stolen  the  property; 
or  he  may  have  borrowed  or  hired  it  for  temporary  use; 
or  he  may  be  the  holder  of  it  in  pledge  for  a  debt  not  yet 
due ;  or,  finally,  he  may  be  merely  the  purchaser  under  a 
contract  of  conditional  sale. 

We  will  now  consider  the  rights  of  third  persons 
where  the  person  in  possession  of  property  holds  it  under 
no  better  right  than  that  of  a  contract  of  conditional  sale. 

The  law  of  California  relating  to  this  topic  furnishes 
an  illustration  of  the  manner  in  which  the  common  law 
prevailing  in  England,  and  generally  in  the  states  of  our 
own  country,  has  been  adopted  and  applied  as  the  law  of 
this  particular  state. 

Cases  on  Conditional  Sales 

The  first  actual  conditional  sales  case  in  the  Cali- 
fornia decisions  seems  to  have  been  Putnam  v.  Lamphier, 
36  Cal.  151  (1868).  Here  the  court  cites  Parsons  on 


156  MERCANTILE  CREDITS 

Contracts  as  follows:  "Where  the  right  to  receive  pay- 
ment before  delivery  is  waived  by  the  seller,  and  imme- 
diate possession  is  given  to  the  purchaser,  and  yet  by  ex- 
press agreement  the  title  is  to  remain  in  the  seller  until 
after  payment  of  the  price  upon  a  fixed  day,  such  payment 
is  strictly  a  condition  precedent,  and  until  performance 
the  right  of  property  is  not  vested  in  the  purchaser" ;  and 
it  was  held  by  the  court  to  be  a  general  rule  that  even  a 
bona  fide  purchaser  from  the  conditional  sale  purchaser 
would  not  take  title  as  against  the  original  seller. 

In  the  case  of  Kohler  v.  Hayes,  4 1  Cal.  455  (1871), 
it  appeared  that  the  plaintiff  had  delivered  a  piano  to  one 
Dowling  on  an  agreement  that  the  same  was  to  be  sold  to 
Bowling  for  a  stated  sum,  to  be  paid  at  the  rate  of  $40 
per  month,  and  that  when  the  entire  amount  should  be 
paid,  a  bill  of  sale  would  be  given.  Dowling,  after  pay- 
ing $100  on  account,  sold  the  piano  to  a  third  person  who 
purchased  in  good  faith  without  notice  of  the  terms  of 
the  conditional  sale.  It  was  held  that  the  title  to  the 
piano  remained  in  Kohler,  and  that  on  the  facts  he  would 
be  entitled  to  recover  possession  in  default  of  payment  of 
the  purchase  price. 

In  Hegler  v.  Eddy,  53  Cal.  597  (1879),  certain 
household  goods  were  delivered  to  Alice  Cumminsky,  to 
be  paid  for  by  instalments.  She  was  to  have  the  right  to 
use  the  furniture  so  long  as  she  should  pay  such  instal- 
ments ;  and,  upon  failure,  the  vendors  might  at  once  take 
possession  of  the  property,  and  the  moneys  already  paid 
were  to  be  forfeited.  Held:  "This  is  not  a  sale  but  only 
a  contract  for  the  sale  of  the  property,  and  the  legal  title 
to  the  property  is  not  thereby  transferred  .or  changed." 

The  principles  above  stated  have  been  approved  from 
time  to  time  down  to  the  latest  cases,  one  of  which  is 
Lundy  Furniture  Co.  v.  White,  128  Cal.  170,  where  an 


LIENS  ON   PERSONAL  PROPERTY  157 

instrument  in  the  form  of  a  lease,  providing  for  payment 
of  rents  until  the  amount  paid  should  equal  the  agreed 
value  of  the  property  (when  a  bill  of  sale  was  to  be 
made),  but  expressly  reserving  title  in  the  vendor  with 
right  to  retake  possession  upon  breach  of  its  conditions, 
was  held  to  be  a  conditional  sale  and  not  a  lease. 

Fraudulent  Contracts  of  Sale 

Sometimes  agreements  supposed  to  be  of  this  kind 
have  been  so  written  that  they  were  held  not  to  be  con- 
tracts of  conditional  sale  and  the  title  passed  to  the  pur- 
chaser, and  sometimes  such  agreements  have  been  held 
invalid  as  an  attempt  to  evade  the  laws  concerning  the 
recording  of  mortgages.  For  instance,  in  Palmer  v. 
Howard,  72  Cal.  293  (1887).  The  agreement  lacked 
two  of  the  usual  earmarks  of  a  conditional  sale:  (i)  No 
bill  of  sale  was  to  be  given  on  payment  of  the  purchase 
price;  and  (2)  if  the  purchaser  failed  to  meet  the  pay- 
ments, the  vendor  might  take  and  sell  the  property;  but 
in  so  doing  he  must  account  for  any  surplus  above  the 
agreed  price  and  expenses  of  the  sale.  Here  the  court 
said  that  it  must  be  remembered  that  the  policy  of  the 
law  is  against  upholding  secret  liens  and  charges  to  the 
injury  of  innocent  purchasers;  and  that  mortgages  of  per- 
sonal property  are  permitted  only  in  certain  specified  cases 
and  under  specified  conditions,  intended  to  give  notice 
to  the  world  of  the  character  of  the  transaction  and  that 
when  such  conditions  had  not  been  complied  with,  the 
court  would  give  effect  to  the  transaction  according  to  its 
true  character,  and  not  by  the  mere  name  given  to  it  by 
the  parties. 

Again,  in  other  cases — as  where  a  harvester  was  sold 
and  delivered  to  the  purchaser  under  an  agreement  to 
give  notes  for  the  purchase  money,  and  under  the  terms 


I58  MERCANTILE  CREDITS 

of  an  absolute  sale  passing  title  to  the  purchaser — such 
absolute  sale  cannot  afterwards  be  converted  into  a  con- 
ditional sale,  without  any  change  of  possession,  by  a  mere 
agreement  between  the  parties. 


CHAPTER  IX 

LIENS  ON  REAL  ESTATE* 
BY  HON.  LEE  C.  GATES 

Practical  Importance  of  the  Subject 

The  present  chapter  is  not  a  technical  discussion  of 
liens  on  real  estate,  but  is  intended  for  business  men 
and  students  of  practical  business  life.  For  twenty  years 
and  more  the  institution  with  which  the  writer  is  con- 
nected has  been  engaged  in  the  study  of  liens,  titles,  and 
matters  affecting  the  titles  to  real  estate.  All  who  are 
interested  in  real  estate,  either  as  purchasers  or  as  en- 
cumbrancers, i.  e.,  men  who  take  mortgages  and  accept 
liens  upon  real  estate,  understand  the  importance  of 
thorough  investigation  as  to  previous  liens.  Examina- 
tion of  title  for  the  purpose  of  investment  in  real  estate, 
is  undertaken  mainly  for  two  classes  of  people — those 
who  buy,  and  those  who  loan  money  upon  real  estate. 
Men  who  own  property  do  not  as  a  rule  undertake  to 
examine  their  titles  until  they  are  about  to  dispose  of  it, 
and  the  result  is  that  many  properties  are  sold  for  liens 
which,  without  the  knowledge  of  the  owner,  have  attached 
thereto. 

General  Nature  of  Liens 

A  lien  is  a  claim  that  attaches  to  property,  either  by 
contract  or  by  the  operation  of  law.  If  you  loan  your 


*It  is  impossible  to  give  the  varying  lien  laws  of  the  different  states  in  the  present 
volume.  The  California  law  which  is  discussed  here  will  give  a  fair  idea  of  the  general 
law  of  liens  and  will  indicate  what  the  credit  man  must  look  for  when  investigating  the 
matter  in  other  states. 

159 


160  MERCANTILE  CREDITS 

money  on  a  piece  of  property,  you  have  created  a  lien  by 
contract.  A  tax  lien,  however,  is  created  by  law;  a  street 
assessment  is  also  a  lien  created  by  law.  These  are  in- 
voluntary liens,  and  many  people  do  not  know  anything 
about  them.  We  shall  therefore,  in  our  discussion  of  the 
general  subject  of  liens,  endeavor  to  ascertain  what  they 
are,  where  they  exist,  and  to  what  extent  and  for  what 
length  of  time  they  are  binding  on  property. 

Taxes  as  Liens 

We  shall  discuss  first  the  subject  of  taxes  as  liens 
which  attach  on  all  property.  In  the  state  of  California, 
a  few  years  ago,  we  adopted  an  amendment  to  the  Con- 
stitution, providing  that  state  taxes  were  to  be  levied  on 
the  public  utility  corporations  of  the  state — the  power, 
gas,  electric,  telephone,  railroad,  and  express  corpora- 
tions— and  these  public  utility  corporations  were  to  pay 
us  a  certain  percentage  of  their  gross  income.  We  also 
levy  a  tax  on  the  capital  stock  and  surplus  of  our  banks. 
We  levy  these  taxes  directly  upon  the  property  of  the 
corporations,  and  such  taxes  become  a  lien. 

The  Franchise  Tax 

Then,  there  is  the  franchise  tax — a  tax  levied  upon 
the  right  to  be  a  corporation.  A  corporation  is  a  crea- 
ture of  law,  brought  into  existence  by  general  statute,  and 
we  impose  a  franchise  tax  upon  it.  Many  people  doubt 
the  wisdom  of  this  tax,  and  there  is  much  caviling,  much 
abuse,  and  remonstrance  against  it;  but  it  is  imposed  by 
our  Constitution,  and  cannot  be  revoked  except  by  an 
amendment  thereto.  This  tax,  therefore,  is  a  lien  on  the 
property  of  every  corporation.  If  a  corporation  under- 
takes to  sell  a  certain  piece  of  its  property,  any  unpaid 
franchise  tax  is  a  lien  upon  that  property — a  lien  renewed 


LIENS  ON  REAL  ESTATE  161 

every  year;  and  if  it  is  not  paid  one  year  it  does  not  out- 
law like  a  mortgage,  but  accumulates.  The  tax  of  last 
year,  of  this  year,  and  of  next  year  become  liens,  and 
continue  so  year  after  year.  None  of  them  outlaw,  and 
none  die.  The  statute  of  limitations  never  operates 
against  a  state,  a  city,  or  a  municipality.  An  obligation 
to  any  one  of  these  is  perpetual;  and  a  business  man 
recognizes  as  a  "preferred"  lien  the  taxes  standing 
against  the  property  of  either  a  corporation  or  an  in- 
dividual. This  condition  is  the  reverse  of  the  status  of 
ordinary  claims. 

The  License  Tax 

In  California  there  is  yet  another  tax — found  in  few, 
if  any,  other  states — which  is  a  lien  on  the  property  of  a 
corporation;  viz.,  the  license  tax.  Some  years  ago,  in 
order  to  raise  revenue,  a  graduated  tax  falling  due  every 
year  was  laid  on  the  capital  stock  of  corporations.  Unless 
this  tax  is  paid  within  the  time  fixed  by  law,  the  penalty 
is  not  merely  a  lien  on  the  real  estate,  but  the  existence  of 
the  defaulting  corporation  is  destroyed.  It  forfeits  its 
charter.  It  is  no  longer  allowed  to  continue  business.  By 
its  failure  to  pay  the  tax,  it  ceases  to  be  a  corporation. 

This  license  tax  is  something  about  which  most  people 
connected  with  corporations  know  little,  unless  they 
happen  to  be  trained  lawyers  who  have  made  a  special 
study  of  the  laws  on  this  subject.  Many  think  when  they 
pay  one  of  these  taxes,  usually  the  franchise  tax,  that  they 
have  paid  both;  and  there  are  accordingly  30,000  cor- 
porations in  this  state  which  have  forfeited  their  charters 
since  the  license  tax  law  went  into  effect,  and  the  license 
tax  remains  a  lien  against  the  property  of  these  different 
corporations. 

Under  the  Constitution  of  California  as  it  stood  prior 


162  MERCANTILE  CREDITS 

to  1910,  no  statute  could  be  passed  by  which  a  corpora- 
tion could  be  revived,  so  that  a  failure  to  pay  the  taxes 
in  1907,  1908,  or  1909,  left  that  corporation  non-exist- 
ent. It  could  continue  in  business,  for  the  law  is,  that 
affairs  of  a  dissolved  corporation  pass  into  the  hands  of 
the  directors  who  are  in  office  at  the  time  of  forfeiture  for 
liquidation,  but  there  was  no  provision  in  the  law  by 
which  it  could  be  resurrected.  To  remedy  this  we  had  to 
adopt  the  constitutional  amendment  of  1910,  providing 
that  a  corporation  could  be  revived  by  the  payment  of  its 
taxes  and  of  all  the  penalties  accrued  against  it.  Now 
upon  the  payment  of  such  taxes  to  the  Secretary  of  State, 
and  the  issuance  by  him  of  a  certificate  to  that  effect,  a 
corporation  is  reclothed  with  its  powers.  In  other  words, 
it  can  die,  and  then  be  resurrected  by  the  payment  of  a 
tax. 

The  license  tax  has  brought  annually  into  the  treasury 
of  California  something  like  $800,000,  but  now  we 
want  to  abolish  it,  principally  because  of  its  disastrous 
consequences. 

The  Poll  Tax 

There  is  another  tax  in  California  which,  though  not 
a  property  tax,  becomes  yet  a  lien  on  real  estate  owned 
by  the  man  who  fails  to  pay  it.  That  is  the  poll  tax  of 
two  dollars  on  every  male  citizen  of  the  state.  A  peti- 
tion to  abolish  the  poll  tax  is  being  circulated,  but  the 
movement  is  of  doubtful  wisdom.  It  is  worth  two  dollars 
to  be  a  citizen  of  the  state  of  California;  and  moreover, 
the  proceeds  of  this  tax  form  a  part  of  the  fund  that  has 
been  used  to  build  up  our  public  schools.  Its  abolition 
would  mean  the  loss  to  our  treasury  of  another  $800,000. 

Your  poll  tax  if  not  paid  gets  to  be  $3  and  $4,  be- 
coming a  lien  on  the  real  estate  of  the  man  who  owes  it. 


LIENS  ON  REAL  ESTATE  163 

Many  a  time  when  property  has  been  sold,  the  purchaser 
has  found  that  the  poll  tax  has  not  been  paid,  and  that  a 
lien  attaches  to  the  property  and  must  be  paid  later. 
Sometimes  property  has  been  sold  because  of  this  unpaid 
poll  tax.  I  have  happened  upon  many  cases  where  the 
poll  tax  with  the  costs  made  a  considerable  sum  to  be  paid 
in  order  to  release  property. 

Selling  Property  for  Taxes 

It  will  be  understood  that  when  you  buy  property  on 
which  the  taxes  have  not  been  paid,  there  is  a  tax  lien 
upon  it — an  involuntary  lien.  You  cannot  escape  it. 
Taxes  are  levied  and  they  become  a  lien.  You  have  to 
take  care  of  them,  or  your  property  will  be  sold. 

Under  the  California  law  passed  in  1897,  all  property 
in  such  cases  is  sold  to  the  state.  Up  to  that  time  it  could 
be  sold  to  any  man  who  would  pay  the  taxes  on  any  par- 
ticular piece  of  property,  in  return  for  a  certain  propor- 
tion of  that  property,  the  successful  bidder  being  the  one 
content  with  the  smallest  amount.  Sometimes  it  happened 
that  a  man  would  offer  to  pay  the  taxes  on  a  piece  of 
property  on  one  of  our  streets,  for  the  front  inch  of  the 
property.  Some  other  man  would  say,  "I'll  take  a  half 
inch,"  and  another,  "I'll  take  a  quarter,"  bidding  against 
each  other,  until  it  reached  a  point  where  there  were  no 
numbers  left  to  register  the  bids.  Well,  the  one  offering 
to  take  the  least  would  get  it;  and  he  would  get  a  tax 
certificate,  and  later  on,  a  tax  deed,  if  it  were  not  re- 
deemed. Of  course,  you  can  understand  that  there  is  no 
proper  use  an  individual  could  make  of  a  millionth  of  an 
inch  of  land  even  on  Spring  Street  or  Broadway,  and  this 
custom  led  to  abuses.  Now,  therefore,  the  state  becomes 
the  purchaser  of  all  property  sold  for  taxes.  It  takes  a 
certificate  of  purchase  after  one  year;  and  after  five  years 
it  gets  a  deed,  and  can  sell  the  property. 


164  MERCANTILE  CREDITS 

Abuse  of  Private  Tax  Sales 

Under  the  old  law  there  were  men  who  made  it  a  busi- 
ness to  buy  tax  sales,  attending  regularly  when  the  sales 
were  held,  and  buying  all  they  could.  They  then  got  tax 
deeds,  and  in  time  it  became  a  question  whether  their 
title  could  be  sustained  by  a  suit,  or  whether  they  would 
accept  a  certain  sum  of  money  and  let  the  property  go. 
This  grew  into  a  very  pernicious  and  disgraceful  practice. 
There  were  "tax  sharps,"  as  we  called  them,  who,  after 
they  got  a  deed  costing  $1.25,  or  $1.50,  or  $3,  would  ask 
$100  for  a  quit-claim  deed  to  convey  back  the  interest 
thus  obtained,  and  so  manage  the  matter  that  it  was 
cheaper  to  pay  than  fight. 

So  far  was  this  carried  that  it  became  necessary  to 
amend  the  law;  and  later,  we  passed  an  amendment  by 
which  the  state  bought  all  the  property,  and  then  we  got 
rid  of  that  practice  forever. 

Tax  Titles 

Tax  titles,  I  may  observe,  have  been  throughout  all 
history  a  very  precarious  class  of  titles.  Very  few  tax 
titles  have  ever  been  held  valid  in  the  state  of  California, 
or  in  fact,  in  any  other  jurisdiction.  You  cannot  buy  a 
tax  title  with  any  degree  of  certainty  that  the  owner  will 
not  be  able  to  set  aside  your  title  and  recover  his  property. 
Recently  the  courts  have  upheld  some  few  tax  titles ;  but 
you  can  usually  set  aside  a  tax  sale,  though  you  may  have 
to  expend  several  times  the  amount  of  money  that  re- 
demption would  have  cost.  Usually  it  costs  less  to  buy 
off  the  owner  of  the  tax  title  than  it  does  to  bring  a  suit 
and  go  through  the  various  courts  to  a  final  decree. 

City  and  Special  Taxes 

In  California  there  are  so  many  liens  included  under 


LIENS  ON  REAL  ESTATE  165 

the  head  of  city  taxes  that  I  have  not  space  to  enumerate 
them.  We  have  the  street  lien,  the  sidewalk  lien,  the 
sewer  lien,  the  shade  tree  lien,  the  protection  district  lien, 
the  school  district  lien — and  all  these  assessments  must 
be  taken  care  of  and  watched. 

When  you  go  out  into  the  country  you  find  matters  but 
little  better.  There  are  already  sanitation  tax  districts, 
and  recently  a  bill  has  been  proposed,  which,  if  passed, 
will  levy  a  tax  on  the  real  estate  in  a  certain  district  for 
the  prevention  of  the  flow  of  water  into  oil  wells.  Taxes 
and  assessments  are,  in  fact,  almost  limitless  in  number; 
and  any  property  owner  or  business  man  must  be  very 
careful  to  ascertain  what  they  all  are,  or  he  will  find  his 
property  sold,  and  will  have  to  pay  a  large  amount  of 
money,  comparatively  speaking,  as  the  penalty  for  allow- 
ing it  to  be  sold.  Indeed,  I  might  say  things  have 
reached  the  point  in  California  where,  if  you  desire  to 
escape  liens  of  taxes  or  assessments,  you  have  to  hire  a 
lawyer,  and  a  good  one,  or  you  will  be  mulcted. 

The  Inheritance  Tax 

Still  another  kind  of  tax  is  the  inheritance  tax.  We 
are  increasing  the  taxes  on  inheritances,  though  we  are 
still  a  little  behind  other  countries  in  that  respect.  The 
tax  on  the  property  of  the  man  who  dies  is  the  only  tax 
that  no  one  ever  pays;  for  certainly  the  man  that  dies 
does  not  pay  it. 

A  few  years  ago  an  indignant  young  fellow  came  to 
my  office  desiring  me  to  prevent  the  levying  of  a  tax  in 
the  state  of  Illinois  on  an  inheritance  which  he  had  re- 
ceived from  an  aunt.  The  amount  of  money  was 
$30,000,  and  he  was  outraged  to  think  that  the  state  of 
Illinois  wanted  to  take  something  like  $1,800  of  it,  leav- 
ing but  $28,200  for  him.  He  wanted  me  to  bring  a  suit. 


i66  MERCANTILE  CREDITS 

He  said,  "They  have  no  right  to  take  that  money  from 
me."  "Why/'  said  I,  "they  didn't  take  it  from  you.  Did 
you  ever  have  it?"  "No,"  he  answered,  "but  my  aunt 
gave  it  to  me."  "All  right.  Your  aunt  didn't  give  you 
all  of  it.  She  couldn't.  The  state  of  Illinois  said  she 
could  only  give  you  $28,200,  and  you  are  getting  it.  You 
don't  pay  that  $1,800,  for  you  never  had  it;  and  your 
aunt  doesn't  pay  it,  because  she  has  passed  away." 

The  whole  matter  of  inheritance  is  a  matter  of 
statute.  Unless  the  statute  said  so,  your  children  could 
not  inherit  one  dollar.  If  there  was  no  law  on  the  sub- 
ject, and  I  died,  my  property  would  go  to  the  state. 
There  is  no  natural  right  to  inherit.  That  being  true,  the 
state  can  tax  property  which  passes  from  a  decedent  to 
the  heirs  in  such  sums  as  it  sees  fit.  Large  fortunes 
should  be  taxed  heavily.  If  a  man  dies  leaving  several 
millions,  the  state  ought  to  receive  a  very  large  share  of 
it,  because  no  one  can  make  a  million  dollars;  he  only 
obtains  it  by  virtue  of  the  operation  of  the  laws  which 
have  permitted  him  to  do  so. 

Judgments 

All  tax  liens  are  involuntary  liens — liens  you  must 
care  for,  or  your  property  will  be  forfeited.  Now  I  want 
to  take  up  another  lien,  which  partakes  of  the  nature  of 
an  involuntary  lien;  that  is,  an  attachment,  including  all 
such  claims  as  come  under  the  general  head  of  "Judg- 
ments and  Attachments."  Under  the  California  law  a 
judgment  obtained  by  one  party  against  another  in  a  suit 
becomes  a  lien  on  all  the  real  estate  then  owned  by  the 
debtor,  or  acquired  by  him  thereafter  during  the  life  of 
that  lien.  A  judgment  operates  instantly  on  all  the  prop- 
erty in  the  county,  and,  if  the  debtor  has  property  in 
another  county,  the  man  who  obtains  the  judgment — the 


LIENS  ON  REAL  ESTATE  167 

judgment  creditor — can  send  a  transcript  of  that  judg- 
ment into  that  county  and  have  it  levied  there.  But  if  a 
judgment  is  obtained  before  a  justice  of  the  peace,  it  does 
not  become  a  lien  on  real  estate  until  an  abstract  of  the 
judgment  is  recorded  in  the  recorder's  office.  A  judgment 
rendered  by  a  court  of  record,  when  docketed  in  the 
county  clerk's  office  remains  a  lien  on  all  the  property  for 
five  years,  and  may  be  renewed  at  any  time  after  five  years 
upon  suit  brought  for  that  purpose,  or  at  any  time  before 
the  five  years  have  elapsed,  by  a  mere  motion.  At  the 
end  of  five  years  you  may  issue  an  execution  of  judgment 
and  levy  upon  property,  selecting  any  particular  property 
you  desire.  The  lien  of  the  judgment  becomes  the  lien 
of  levy  and  execution,  and,  on  the  sale  of  the  property  by 
the  sheriff,  it  merges  into  the  certificate  of  sheriff's  sale. 

Sheriff's  Certificate  of  Sale 

Now,  up  to  the  time  of  the  issue  of  such  certificate 
the  judgment  is  not  a  lien  against  a  deed,  though  unre- 
corded. For  instance,  if  Mr.  Blank  held  from  me  a  deed 
which  he  had  not  placed  on  record,  and  some  one  of  my 
numerous  creditors  were  to  sue  me,  get  judgment  against 
me,  and  levy  an  execution  on  the  property  standing  in  my 
name,  Mr.  Blank  could  come  in  and  put  his  deed  on 
record;  whereupon  the  judgment  lien  would  be  found 
inferior  to  his  deed.  But  if  he  waited  until  the  sheriff's 
certificate  of  sale  had  been  made  and  issued,  such  certifi- 
cate would  take  precedence.  The  sheriff's  certificate  of 
sale  remains  a  lien  until  the  end  of  the  year,  during  which 
time  the  owner  may  redeem  his  property,  and  after  that 
time  it  merges  into  a  deed,  and  title  passes. 

Attachments 

Antecedent  to  the  judgment  is  the  attachment.    A  man 


1 68  MERCANTILE  CREDITS 

desiring  to  obtain  a  judgment  against  a  debtor,  may, 
under  certain  circumstances,  attach  a  particular  piece  of 
property.  Such  attachment  becomes  a  lien,  which  holds 
that  property  as  against  any  other  attachment  or  any 
other  lien,  mortgage,  deed  of  trust,  or  otherwise,  until 
the  judgment  is  either  rendered  or  denied.  If  the  suit 
results  in  a  judgment  of  non-suit,  that  is,  if  the  plaintiff 
gets  no  judgment,  this  decision  instantly  dissolves  the 
attachment;  but  if  he  gets  a  judgment  against  the  man 
whose  property  he  has  attached,  that  judgment  becomes 
a  lien  not  only  on  the  particular  property  attached,  but 
also  on  all  the  property  owned  by  the  judgment  debtor  in 
that  county. 

The  Homestead  Exemption 

Now  that  attachment  is  a  lien.  It  is  not,  however,  a 
lien  as  against  an  unrecorded  deed  of  date  prior  to  the 
attachment;  neither  is  it  a  lien  as  against  a  homestead, 
which  may  be  declared  by  the  owner  of  the  property  even 
after  an  attachment  has  been  levied.  This  is  another 
peculiarity  of  our  California  law.  The  homestead  ex- 
emption is  not  an  involuntary  proceeding.  In  many  of 
the  states,  when  one  takes  property,  the  homestead  right 
attaches  instantly;  but  in  the  state  of  California  there  is 
no  homestead  until  the  owner  of  the  property,  or  the 
person  who  claims  an  interest  in  the  property,  makes  his 
declaration  of  homestead  and  files  it  in  the  recorder's 
office.  So  that,  if  my  property  were  attached  tomorrow 
by  some  one  of  my  numerous  creditors,  tired  of  listening 
to  my  excuses,  I  could  defeat  the  attachment  by  levying 
a  homestead  lien  upon  my  property,  whereupon  the 
attachment  would  go  for  naught.  But  if  I  waited  until 
that  creditor  got  a  judgment,  the  homestead  exemption 
would  be  of  no  value. 


LIENS  ON  REAL  ESTATE  169 

The  Torrens  Land  Law  Registry  System 

The  Torrens  Land  Law  Registry  System,  which  has 
been  on  the  books  in  the  state  of  California  since  1897, 
is  a  system  by  which  each  owner  may  have  his  land  certi- 
fied by  the  county  recorder,  as  the  registrar,  who  gives 
him  a  certificate.  Now,  under  this  system,  the  man  who 
gets  a  judgment  does  not  have  a  lien  on  all  the  debtor's 
property  in  the  county,  but  only  on  those  lands  which  he 
knows  to  be  the  debtor's  property.  He  has  to  go  to  the 
recorder's  office  and  select  the  lands. 

The  Torrens  Land  Law  Registry  System  has  never 
been  very  effective  in  this  state  and  an  endeavor  is  now 
being  made  to  amend  and  improve  it.  If  the  proposed 
amendment  goes  into  effect,  it  will  greatly  modify  the 
present  conditions,  of  which  the  limited  judgment  lien  is 
one  feature. 

Benefits  of  the  Mortgage  Lien 

I  come  now  to  the  mortgage  lien — the  most  familiar 
of  all.  There  are  few  people  who  are  entirely  unac- 
quainted with  mortgages.  It  is  a  very  poor  man  indeed, 
and  a  very  thriftless  man  too,  who  has  never  been  able  to 
borrow  money  on  a  mortgage.  The  whole  advance  of 
commercial  civilization  has  been  on  borrowed  money,  and 
while  we  have  come  to  look  on  a  man  who  loans  us  money 
on  our  real  estate  as  an  enemy,  there  is,  in  my  opinion, 
no  more  misleading  and  mischievous  idea.  The  laws 
which  give  to  the  creditor  the  protection  of  this  security 
enable  him  to  loan  his  money  to  the  individual  who  can 
furnish  that  security,  the  two  men  working  hand  in  hand. 
I  might  say  that  our  banking  fraternity — the  men  en- 
gaged in  receiving  the  idle  moneys  of  the  country  and 
turning  them  into  the  channels  of  trade — are  performing 
a  very  valuable  service  for  the  people  of  the  communities 
in  which  they  live. 


1 70  MERCANTILE  CREDITS 

Trust  Deeds 

A  trust  deed  given  to  secure  borrowed  money  is  not 
technically  a  lien  on  the  land  it  covers ;  it  is  a  conveyance 
of  the  title  to  secure  the  loan.  It  is,  however,  really  only 
a  form  of  mortgage — though  not  so  called — and  is  very 
frequently  employed.  There  is  a  provision  in  our 
statutes  which  says  that  a  conveyance  of  title  as  security 
for  a  debt,  whatever  its  form,  is  in  effect  a  mortgage,  so 
that  if  you  take  a  deed  from  me  as  security  for  a  debt  of 
$500,  that  deed,  while  it  appears  to  pass  title  on  its  face, 
is,  in  fact,  only  a  mortgage;  and  if  you  want  to  get  the 
property,  you  must  go  into  the  courts  and  foreclose  it  as 
though  you  held  a  mortgage. 

Now,  under  our  theory  of  law  in  California  a  mort- 
gage is  only  a  lien.  It  does  not  pass  the  title.  In  some 
other  states  the  mortgage  passes  the  title — a  mortgage  is 
simply  a  conveyance  of  the  title;  and  the  mortgagor  can 
compel  the  mortgagee  to  transfer  it  back  to  him  when  he 
pays  the  debt.  The  lien  theory  of  mortgages,  however, 
is  that  on  which  we  proceed  in  California ;  and,  therefore, 
a  deed  taken  to  secure  a  debt  does  not  really  convey  the 
title.  Now  observe  the  possible  result  of  this:  If  Mr. 
Blank  takes  a  deed  from  me  to  secure  a  loan  of  $500,  the* 
law  says  I  still  have  the  title  although  he  has  the  deed,  for 
he  has  in  effect  only  a  mortgage;  but  if  he  sells  the  prop- 
erty to  some  third  person  who  does  not  know  anything 
about  it,  and  who  buys  it  in  ignorance  of  the  fact  that  I 
still  have  the  title,  the  law  very  properly  says  that  this 
innocent  purchaser  from  Mr.  Blank  gets  the  title.  In 
other  words,  Mr.  Blank  is  able  to  give  the  other  man 
something  that  he  never  possessed.  This  is  necessary  for 
the  protection  of  the  innocent  purchaser,  for  no  man 
would  be  able  to  buy  property  without  security  except 
under  such  protection. 


LIENS  ON  REAL  ESTATE  171 

Deed  Not  Effective  Until  Delivered 

Delivery  of  property  by  a  deed  of  title  does  not  pass 
until  the  deed  has  been  delivered.  It  is  a  common  thing 
for  a  husband  to  make  out  a  deed  to  certain  property  in 
favor  of  his  wife,  and  to  put  that  deed  into  a  safe  waiting 
for  one  of  them  to  die,  intending,  in  the  event  of  death, 
to  put  it  on  record.  Now,  if  that  deed  is  delivered  either 
to  the  grantee  or  to  a  third  person,  with  instructions  to 
that  third  person  to  deliver  it  to  the  other  upon  the  death 
of  the  grantor,  the  title  will  pass  when  the  second  de- 
livery is  made.  That  is  a  delivery  in  escrow.  But  some- 
times a  man  makes  out  his  deed,  puts  it  in  his  safe,  and 
leaves  it  there,  or  sometimes  the  husband  and  wife  make 
out  two  deeds  and  put  them  in  the  safe,  agreeing  that  the 
title  shall  pass  to  the  survivor  and  in  such  cases  there  is 
no  delivery.  If,  under  these  circumstances,  the  wife 
should  die,  and  the  husband  should  put  her  deed  on  record 
(destroying  his  own  deed),  that  deed  is  absolutely  void. 
If  he  gets  it  on  record,  and  no  one  knows  about  the  de- 
struction of  the  other  deed,  or  if  he  can  apparently  prove 
that  that  deed  had  been  delivered  to  him,  he  may  hold  the 
property;  and  yet,  if  any  of  the  heirs  could  prove  the 
facts  to  be  as  I  have  stated,  they  could  set  aside  the  deed. 

In  other  words,  no  deed  is  effective  until  it  is  de- 
livered. If  I  made  a  note  for  $500  to  Mr.  Blank,  and 
left  it  in  my  desk,  and  never  delivered  it  to  him,  he  would 
not  have  my  note,  and  could  not  collect  on  it;  just  so  with 
a  deed.  Even  if  written  instructions  were  placed  in  the 
safety  depository  directing  the  deed  to  be  delivered  on  the 
death  of  the  grantor,  the  delivery  would  not  be  good. 
The  deed  must  be  delivered,  either  to  the  grantee,  or  to 
some  third  person.  The  only  safe  way,  if  a  man  wants  to 
turn  over  his  property  to  his  wife  on  his  death  so  as  to 
save  administration  papers,  is  to  make  out  a  deed,  take  it 


1 72  MERCANTILE  CREDITS 

to  his  bank,  put  it  in  an  envelope,  and  write  on  the  face 
thereof:  "This  envelope  contains  a  deed  of  certain  prop- 
erty therein  designated.  You  will  hold  this  deed  until 
my  death.  You  will  then  deliver  the  same  to  my  wife." 
Then,  when  that  deed  is  delivered,  the  title  will  pass. 

Law  of  Mortgage  Liens 

A  mortgage  becomes  a  lien  from  the  time  it  is  filed 
for  record  in  the  recorder's  office;  and  it  is  a  lien  as  to 
anybody  who  knows  of  its  existence,  even  though  it  is  not 
filed  of  record.  In  other  words,  you  have  constructive 
notice  of  the  mortgage  by  the  filing  in  the  recorder's 
office;  but  if  you  know  that  mortgage  is  in  existence,  you 
have  actual  notice  and  are  bound  by  it,  regardless  of 
whether  it  is  filed  or  not. 

Legal  Expiration  of  Mortgage  Liens 

A  mortgage  lien  attaches  the  moment  it  is  filed  for 
record  in  the  recorder's  office,  and  it  continues  until  the 
time  of  its  expiration,  and  for  four  years  afterward.  That 
is,  a  mortgage  does  not  outlaw  until  four  years  after  the 
date  of  its  maturity  as  fixed  by  the  court.  The  note,  of 
course,  is  the  principal  obligation.  The  mortgage  is 
merely  an  incident — a  security  for  the  obligation.  There 
is  yet  another  interesting  feature.  Many  times  when  a 
note  has  passed  beyond  maturity,  the  lender  and  the  bor- 
rower are  willing  that  the  mortgage  security  shall  be  re- 
newed without  making  out  new  papers.  They  can  do  it 
by  entering  into  an  agreement  to  postpone  the  payment 
of  that  mortgage  to  a  future  time.  But  can  they  carry  it 
beyond  the  time  when  the  original  papers  would  outlaw? 
They  can,  provided  there  is  no  other  mortgage  or  lien 
after  the  mortgage  which  they  are  thus  renewing.  But 
if  there  is  a  second  mortgage  on  the  property,  the  old 


LIENS  ON  REAL  ESTATE  173 

mortgage  cannot  be  renewed  for  a  longer  period  than  it 
would  run  without  renewal.  In  other  words,  you  cannot 
renew  it  beyond  the  four  years  after  maturity.  If  you 
make  it  longer  than  that,  the  second  mortgage  becomes  a 
first  lien,  and  the  first  mortgage  becomes  a  second  lien. 

Lien  of  the  Deficiency  Judgment 

When  a  suit  is  brought  to  foreclose  a  mortgage,  and 
the  property  has  been  sold  for  less  than  the  mortgage 
debt,  there  comes  into  being  the  deficiency  judgment. 
This  is  a  judgment  entered  and  docketed,  but  which  does 
not  become  a  lien  until  after  the  sale  has  been  made,  and 
the  deficiency  ascertained  and  put  on  the  docket  in  the 
clerk's  office.  It  then  becomes  a  lien  on  what?  It  is  not 
a  lien  on  the  property  which  has  been  sold  by  the  sheriff, 
unless  the  owner  redeems  it,  when  it  will  instantly  attach 
as  a  lien.  To  exemplify,  if  Mr.  Blank  had  foreclosed  a 
mortgage  against  me,  and  after  that  I  came  in  and  re- 
deemed the  property  which  had  been  sold  to  him,  by  pay- 
ing him  the  purchase  price  and  one  per  cent  interest  on  it, 
the  deficiency  judgment  which  he  had  against  me  would 
instantly  become  a  lien  on  the  property  in  my  hands.  But 
if  I  should  sell  to  some  one  else  an  equity  in  the  property, 
and  that  person  redeems,  the  deficiency  judgment  does  not 
become  a  lien.  So  where  there  is  a  deficiency  judgment, 
the  judgment  debtor  rarely  redeems  if  he  consults  an 
attorney. 

Rights  of  Second  Mortgage 

There  is  another  curious  feature  of  the  law,  which 
resulted  some  years  ago  in  the  loss  of  a  lien  by  a  very 
capable  lawyer,  who  had  neglected  to  look  up  the  law  in 
the  matter.  A  man  had  a  second  mortgage,  and  in  a  suit 
which  was  brought  by  the  first  mortgagor  to  foreclose, 


174  MERCANTILE  CREDITS 

he  went  into  court  and  asked  that  the  court  foreclose  his 
mortgage  also,  which  he  had  a  right  to  do  by  cross  com- 
plaint. This  was  done.  When  the  property  was  sold  it 
brought  a  little  less  than  the  face  of  the  first  mortgage. 
The  second  mortgagee  then  offered  to  redeem,  but  accord- 
ing to  the  law  he  could  not  redeem  because  he  had  no  lien 
on  the  property.  He  had  foreclosed  his  mortgage  and  it 
was  no  longer  a  lien.  He  lost  out  because  he  had  done 
the  wrong  thing  in  foreclosing.  If  he  had  gone  into  the 
suit  and  asked  that  any  surplus  after  the  sale  of  the  prop- 
erty under  the  first  mortgage  be  paid  upon  his  own  mort- 
gage, he  would  have  had  a  right  to  redeem,  because  he 
would  still  have  had  a  mortgage;  but  having  passed  his 
mortgage  into  a  decree  of  foreclosure,  it  was  no  longer  a 
lien  on  that  particular  property,  and  he  could  not  redeem. 
In  California  a  mortgage  when  foreclosed  takes  title 
when  the  sheriff's  deed  has  been  issued;  and  we  have  ex- 
tended the  time  of  redemption  from  six  months  to  a  year. 

Law  of  Trust  Deeds 

Now  let  us  go  back  to  trust  deeds,  which,  as  I  said, 
are  not  liens,  but  take  the  place  of  liens.  At  nearly  every 
session  of  the  legislature  there  is  an  agitation  about  re- 
pealing trust  deeds.  When  you  make  a  trust  deed  you 
pass  the  title  to  the  trustee — usually  a  third  person, 
although  I  can  make  a  trust  deed  to  Mr.  Blank  covering 
my  property,  for  a  debt  owing  to  him,  and  he  then  be- 
comes both  the  debtor  and  the  trustee.  Our  law  has 
sanctioned  this  procedure,  but  as  a  rule  a  deed  of  trust  is 
made  by  A  to  B  for  the  benefit  of  C.  A  borrows  of  C, 
say,  $2,000.  He  makes  a  deed  to  B  of  the  property 
which  is  to  be  the  security  for  the  payment  of  that  debt, 
and  he  gives  to  B  the  power,  in  case  he  himself  shall  fail 
to  pay  the  money,  to  sell  that  property  upon  a  compara- 


LIENS  ON  REAL  ESTATE  175 

tively  short  notice  and  in  a  comparatively  expeditious 
way,  and  pay  the  debt.  In  other  words,  deeds  of  trust,  as 
now  drawn,  usually  provide  that  if  the  debtor  fails  to 
pay,  or  makes  default  in  the  payments  required  under  the 
deed  of  trust,  the  trustee  may  publish  a  notice  for  si* 
weeks  in  some  newspaper.  When  the  property  is  sold  at 
the  end  of  that  time,  the  title  passes  immediately  to  the 
purchaser,  without  any  right  of  redemption  on  the  part  of 
the  maker.  That  is  too  harsh,  you  say,  too  dangerous; 
you  can  sell  a  man  out  in  too  short  a  time.  But  you  cannot 
sell  him  out  unless  he  fails  to  pay  his  debt,  or  defaults  in 
his  payment.  If  he  makes  his  payments,  the  trustee  has 
no  power  whatever. 

Advantages  of  Trust  Deeds 

Now  I  will  show  you  how  the  trust  deed  works  in  the 
upbuilding  of  a  new  country.  For  example,  there  are 
thousands  of  tracts  of  land  now  being  opened  around  the 
city  of  Los  Angeles,  and  the  owners  of  those  tracts  divide 
them  into  lots,  and  build  houses  on  the  various  lots.  They 
sell  each  house  and  lot  to  an  individual,  who  is  usually  a 
man  of  limited  means.  We  will  say  that  such  a  house  and 
lot  is  worth  $2,500.  The  owners  of  the  tract  will  be  able 
to  borrow  from  a  bank  possibly  $1,500  on  that  house  and 
lot.  They  give  a  mortgage  to  the  bank  for  that  amount, 
and  that  is  a  first  lien.  The  owners  will  then  sell  to  the 
individual  purchaser,  and  allow  him  to  pay  perhaps  $250 
down,  taking  a  deed  of  trust  from  him  for  the  remainder 
of  the  purchase  price,  which  is  to  be  paid  back  on  instal- 
ments. These  payments  are  arranged  so  that  the  pur- 
chaser can  make  them  out  of  his  limited  means  without 
too  much  difficulty;  and  hundreds  and  thousands  of  homes 
are  being  paid  for  in  that  way. 

Now,  would  the  owner  of  the  property  be  able  to  do 


176  MERCANTILE  CREDITS 

this  in  any  other  way?  Could  he  take  a  second  mortgage, 
allowing  the  purchaser  to  pay  it  back  in  instalments?  In 
that  case,  if  the  purchaser  were  to  default  in  making  his 
payments,  the  owner  of  the  property,  the  seller,  would 
lose  heavily.  He  must  have  such  an  instrument  that  he 
can  quickly  take  the  property  back  in  case  the  individual 
fails  to  make  his  payments,  otherwise  he  could  not  afford 
to  sell  on  such  terms.  If  he  had  to  take  a  second  mort- 
gage to  secure  his  claim  on  the  property,  and  the  man 
defaulted,  what  would  he  do  ?  He  would  have  to  hire  a 
lawyer,  he  would  have  to  go  into  court  and  bring  a  suit, 
and  then  wait  three  or  four  months.  He  would  then  have 
to  sell  the  property  after  it  had  been  advertised  for  three 
weeks,  and  then  wait  a  year  before  he  got  possession,  be- 
cause the  purchaser  would  be  in  possession,  and  you  can- 
not take  property  away  from  the  legal  owner  under  a  full 
year.  If  we  were  without  the  security  afforded  by  the 
trust  deed  for  the  owner  who  sells  his  property  on  small 
payments,  it  would  be  eighteen  months  before  he  could 
get  his  title  back  in  case  of  default;  and  if  the  purchaser 
had  to  give  a  second  mortgage,  he  would  have  to  put  up 
$500  or  $1,000  for  it,  and  under  these  hard  terms,  thou- 
sands of  poor  men  would  be  unable  to  begin  payment  for 
a  home.  Now  that  is  a  part  of  the  deed  of  trust  theory. 
A  deed  of  trust  passes  the  title ;  but  there  is  an  expeditious 
method  by  which  the  owner  can  recover  his  property  after 
a  default  has  occurred  and  the  purchaser  has  failed  to 
make  his  payments.  Once  in  a  while  the  owner  of  a  debt 
will  be  harsh,  and  he  will  declare  a  default  within  a  few 
days  after  the  debt  becomes  due;  but  in  the  large  majority 
of  instances  the  owner  is  willing  to  allow  a  man  30  days 
in  which  to  make  his  payments,  and  trust  deeds  are  so 
written  in  a  good  many  instances  as  to  give  the  purchaser 
fifteen  days  of  grace. 


LIENS  ON  REAL  ESTATE  177 

The  Vendor's  Lien 

There  is  another  lien  which  is  very  little  known,  and 
often  misunderstood.  This  is  the  vendor's  lien  on  real 
estate.  If  I  sell  a  piece  of  land,  and  do  not  take  all  the 
purchase  price,  I  have  a  vendor's  lien  on  that  property  in 
case  I  take  no  other  security;  but  if  I  take  other  security, 
I  have  no  lien.  This  vendor's  lien  is  involuntary,  but  is 
little  used  in  California.  That  is  perhaps  a  fortunate 
circumstance,  because  it  is  so  indefinite  that  no  one  can 
know  exactly  what  his  rights  are  under  such  a  lien. 

The  Mechanic's  Lien 

We  have  not  yet  mentioned  the  mechanic's  lien.  The 
State  Constitution  provides  that  mechanics,  material-men, 
etc.,  shall  have  a  lien  for  the  material  furnished  and  for 
labor  that  has  been  performed.  Some  people  think  that 
we  ought  to  have  a  mechanic's  lien  law  that  would  give  to 
the  laboring  man  and  the  material-man  the  first  lien  on 
the  property  which  is  created  by  them,  over  and  above  a 
mortgage  or  deed  of  trust  which  secured  the  loan,  and 
which  antedated  the  beginning  of  the  building.  They 
say  that  it  is  the  habit  of  mortgagors  and  trustees  to  slip 
in  a  mortgage  just  the  night  before  the  building  is  begun, 
and  thus  get  a  lien  ahead  of  the  mechanic's  lien.  It  is,  of 
course,  a  well-known  principle  of  law  that  a  mortgage  or 
a  deed  of  trust  will  take  precedence  over  a  mechanic's  lien 
if  it  is  filed  before  the  building  is  begun,  or  before  the 
material  is  on  the  ground.  This  is  necessary,  because 
nearly  all  building  operations  are  undertaken  on  bor- 
rowed money,  and  the  money  which  pays  for  the  material 
and  the  labor  is  therefore,  in  most  instances,  borrowed 
money;  and  a  large  part  of  our  building  operations  would 
cease  entirely  if  we  could  not  borrow  the  money  with 
which  to  carry  them  on. 


178  MERCANTILE  CREDITS 

The  Mechanic's  Lien  Law 

The  mechanic's  lien  law  has  passed  through  many 
vicissitudes.  The  Constitution  provides  that  mechanics 
and  material-men  shall  have  a  lien.  It  also  says  that  the 
legislature  shall  provide  by  suitable  legislation  for  the 
enforcement  of  these  liens,  and  the  Supreme  Court  has 
held  that  no  law  existed  for  the  enforcement  of  such  liens 
until  the  legislature  took  proper  action,  and,  although  the 
Constitution  declared  that  the  mechanic  had  a  lien,  he 
actually  had  no  lien.  Laws  have  been  passed  for  the 
enforcement  of  this  lien,  but  the  legislature  at  nearly  every 
session  is  confronted  with  a  number  of  bills  for  the 
amendment  of  these  laws;  and  there  is  a  bill  under  dis- 
cussion now.  The  owner  can  file  his  contract;  but  the 
material-men,  the  contractor,  the  laborer,  and  the  arti- 
sans, may  have  their  liens  on  the  property;  and  if,  under 
this  bill,  they  can  show  that  the  owner  has  been  in  fraudu- 
lent collusion  with  the  contractor,  the  mechanic's  lien  may 
be  greater  than  the  contract  price.  You  have  to  bring 
suit  within  ninety  days,  and  that  suit  when  brought  is  to 
be  tried  in  the  manner  in  which  the  courts  have  tried  these 
cases.  You  can  consolidate  all  of  them,  and  try  them  all 
in  one  suit 

I  am  not  very  familiar  with  the  actual  working  of  the 
mechanic's  lien  law,  because  my  practice  has  not  carried 
me  into  the  courts  in  that  respect;  but,  speaking  generally, 
it  is,  in  my  opinion,  a  very  valuable  law.  This,  together 
with  the  trust  deed  law,  has  enabled  us  to  build  up  the 
southern  part  of  California,  because  the  men  who  furnish 
the  material  and  perform  the  labor  feel  that  they  have  a 
lien  on  the  property  on  which  they  are  to  expend  that 
labor  and  material,  and  that  they  will  be  paid  even  though 
the  owner  shall  refuse  to  pay  them. 


CHAPTER  X 

FRAUDS 
BY  W.  J.  FORD 

Fraud  Not  Always  Legally  Punishable 

The  subject  of  frauds  engages  the  attention  of  the 
district  attorney's  office  more,  perhaps,  than  any  other 
class  of  offenses  against  the  community.  Nevertheless, 
the  number  of  prosecutions  is  limited,  for  the  reason  that 
there  is  a  large  class  of  frauds  for  which  the  law  affords 
no  criminal  remedy,  and  in  many  cases  where  the  law  does 
afford  such  remedy  the  prosecution  is  so  restricted  by  the 
rules  of  evidence  as  to  render  conviction  very  difficult.  In 
cases  where  people  have  obtained  money  under  false  pre- 
tenses— the  most  common  form  of  fraud  and  the  one  most 
difficult  to  deal  with — we  have  really  very  few  prosecu- 
tions. 

The  Several  Varieties  of  Fraud 

Fraud,  as  a  generic  term,  includes  all  acts. of  omission 
and  concealment  injurious  to  some  person  which  consti- 
tute a  breach  of  the  trust  or  confidence  justly  reposed  by 
that  person  in  the  one  guilty  of  the  fraud,  or  acts  by 
which  an  undue  and  unconscionable  advantage  is  taken 
of  another.  Actual  and  positive  fraud  consists  in  cir- 
cumventing, cheating,  or  deceiving  a  person  to  his  injury, 
by  any  cunning,  deception,  or  artifice.  The  term  "legal 
fraud"  has  been  used  to  characterize  the  false  represen- 
tations, more  or  less  innocent,  which  are  reckoned  suffi- 

179 


180  MERCANTILE  CREDITS 

cient  ground  for  rescinding  a  contract  through  a  civil  suit. 
A  "constructive"  fraud  is  held  to  be  an  act  which,  re- 
gardless of  the  motive  of  the  perpetrator,  the  law  de- 
clares to  be  fraudulent  in  itself.  Such  law  is  justified  by 
the  fact  that  certain  acts  carry  in  themselves  irresistible 
evidence  of  fraud,  or  are  liable  to  lead  to  frauds  which 
can  better  be  guarded  against  by  declaring  all  cases  that 
come  within  the  operation  of  a  particular  statute,  frauds 
in  themselves  or  constructive  frauds. 

Contract  to  Sell  Property 

For  example,  a  contract  with  a  real  estate  agent  for 
the  sale  of  a  piece  of  property  must  be  put  in  writing 
before  the  agent  can  collect  his  commission.  If  an  agent 
sells  a  piece  of  property  for  another  without  such  con- 
tract, the  law  will  not  permit  that  agent  to  collect  his 
commission,  even  though  the  agent  is  attempting  to  get 
what  really  and  morally  belongs  to  him.  The  law  does 
not  regard  a  verbal  contract  as  valid  in  such  cases;  for  it 
violates  the  statute  of  frauds. 

The  reason  for  this  ruling  is  that  a  man  may  come  in 
and  voluntarily  offer  his  assistance  in  a  transaction, 
though  neither  of  the  principals  has  really  employed  him 
in  any  capacity  and  neither  of  them  desires  his  assistance. 
If  it  were  not  for  the  statute  of  frauds  such  a  man  could, 
to  use  a  slang  expression,  "butt  in"  on  a  transaction  unin- 
vited, and  then  attempt  to  collect  commission. 

But  it  is  not  this  class  of  frauds  we  are  now  to  discuss. 
The  subject  of  the  prevention  of  fraud  covers  a  wide  field, 
and  only  a  few  special  cases  can  be  taken  up  here. 

Frauds  Punishable  by  Statute 

There  are  many  frauds  which,  according  to  the 
statutes,  may  be  punished  criminally.  Such  is  that  of 


FRAUDS  181 

marrying  under  false  pretenses,  or  obtaining  money  or 
property  by  impersonating  another  in  a  private  or  official 
capacity.  Conveyances  made  with  the  intent  to  deceive 
or  defraud,  as  for  example,  to  deceive,  hinder,  or  delay 
creditors,  are  punishable.  We  have  statutes  against  sell- 
ing land  twice,  by  which  legal  penalties  are  provided  for 
anyone  who  enters  into  a  contract  to  sell  a  piece  of  prop- 
erty to  A,  and  who  before  that  contract  has  been  abro- 
gated, contracts  to  sell  it  to  B  or  C.  We  have  statutes 
forbidding  married  persons  to  represent  themselves  as 
competent  to  sell  real  estate  without  the  concurrence  of 
the  wife  or  husband  in  cases  where  such  concurrence  is 
legally  required.  There  are  also  statutes  against  false 
statements  concerning  the  prices  received  for  consign- 
ments of  goods,  commission  merchants  being  required  to 
make  true  statements  to  their  principals  as  regards  such 
property.  Also,  the  statutes  prohibit  the  removal  of 
mortgaged  personal  property  from  the  county  where  the 
mortgage  is  recorded,  and  mortgaged  property  may  not 
be  further  encumbered  without  notifying  the  owner  of  the 
prior  mortgage,  and  also  notifying  the  second  mortgagee 
that  there  is  already  a  first  mortgage. 

These  are  only  some  of  the  more  familiar  laws  against 
frauds.  All  the  special  statutes  against  fraud  exist  in 
addition  to  the  general  statute  forbidding  the  obtaining 
of  money  under  false  pretenses.  It  would  seem  that  the 
laws  concerning  frauds,  and  making  them  punishable 
through  criminal  prosecution,  are  broad  enough  to  cover 
every  species;  and  yet  they  actually  cover  only  a  small 
proportion  of  the  frauds  that  are  a  matter  of  daily 
occurrence. 

The  Confidence  Man 

In  addition  to  the  criminal  offenses  specifically  desig- 


182  MERCANTILE  CREDITS 

nated  as  frauds,  we  have  the  various  devices  used  by  con- 
fidence men  and  bunco  steerers  for  obtaining  possession 
of  the  property  of  others,  which  are  usually  prosecuted 
and  charged  as  larceny.  Some  of  these  schemes  are 
familiar  to  you.  There  is  the  old-fashioned  one  of  selling 
a  gold  brick,  or  green  goods,  while  a  more  modern  trick 
is  that  of  parting  the  "sucker"  from  his  money  by  means 
of  a  "fake"  lottery  or  other  gambling  schemes.  Often 
such  a  victim  is  ashamed  to  appeal  to  the  police  until  it  is 
too  late  to  secure  a  clue  to  the  whereabouts  of  the  rascals. 

Another  device  as  old  as  telegraphy  and  horse  racing 
is  for  the  swindlers  to  make  acquaintance  with  some 
stranger  and  inform  him  that  they  know  where  there  is  a 
pool  room  in  operation ;  that  they  have  a  friend  who  has 
tapped  a  telegraph  wire  or  is  an  operator,  and  who  can 
delay  the  transmission  to  the  pool  room  of  the  messages 
showing  the  winning  horse  until  they  have  had  time  to  go 
in  and  put  up  a  good  substantial  bet  on  the  real  winning 
horse;  and  that  by  means  of  this  device  they  can  defraud 
the  pool  room.  The  "sucker"  finds  out  that  they  have 
defrauded  him  instead  before  they  get  through. 

Of  course  the  ordinary  business  man,  if  he  is  wise, 
will  never  come  into  contact  with  just  such  tricksters  as 
these;  and  I  mention  them  merely  to  give  a  general  idea 
of  the  fraudulent  schemes  most  common,  and  of  the 
efforts  of  the  law  to  guard  against  them  in  specific 
instances. 

Obtaining  Money  by  False  Pretenses 

Let  us  turn  now  to  the  classes  of  frauds  with  which 
business  men  are  particularly  concerned.  When  you  meet 
a  prospective  customer  you  naturally  inquire  into  his 
character.  You  want  to  know  something  of  his  general 
honesty,  of  his  ability  to  carry  on  the  business  in  which  he 


FRAUDS  183 

is  engaged,  of  the  class  of  customers  he  sells  to  and  of  his 
promptness  in  paying  his  own  debts  and  in  collecting 
moneys  owing  to  him.  In  other  words,  you  want  to  find 
out  if  he  is  a  good  business  man  and,  in  addition  to  that, 
you  want  to  ascertain  what  assets  and  liabilities  he  has. 
These  are  some  of  the  inquiries  which  must  be  made  to 
determine  matters  concerning  credit.  In  case  of  mistake 
there  is  practically  no  redress,  although  the  law  does  pro- 
vide some  remedy,  both  criminal  and  civil,  for  those  from 
whom  money  has  been  obtained  under  false  pretenses. 

Proof  of  Fraud 

In  cases  of  false  representation  there  are  several 
points  which  must  be  established  beyond  all  reasonable 
doubt,  and  it  is  these  points  that  the  credit  man  should 
always  look  into ;  though,  of  course,  he  cannot  under  all 
circumstances  guard  himself  against  an  untruthful  man. 
As  a  rule,  a  man  who  has  some  standing  and  who  wishes 
to  obtain  credit  from  a  mercantile  or  banking  institution, 
is  one  in  whom  the  credit  man  has  confidence.  But  if  he 
lies  as  to  certain  facts,  the  creditor  may  proceed  against 
him  by  criminal  process.  It  is  important,  therefore,  to 
understand  just  the  elements  which  constitute  the  crime 
of  obtaining  money  under  false  pretenses. 

First  of  all,  there  is  the  representation  or  pretense 
which  the  applicant  for  credit  makes,  which  must  be  a 
representation  as  to  an  existing  fact,  or  as  to  some  fact 
that  has  existed  in  the  past.  Representations  as  to  what 
is  likely  to  occur  in  the  future  are  not  punishable  by  law. 
The  law  does  not  require  any  man  to  be  a  prophet  as  to 
the  future,  and  he  cannot  be  prosecuted  because  his  judg- 
ment proves  bad  as  to  what  the  future  may  bring  forth. 

If  I  tell  you  that  during  the  last  month  I  have  sold 
one  thousand  dollars'  worth  of  goods,  I  have  made  a 


184  MERCANTILE  CREDITS 

representation  as  to  a  fact  that  has  existed  during  the 
past  month.  If  I  tell  you  further  that  I  have  in  my 
grocery  store  so  many  cans  of  different  kinds  of  fruit,  so 
many  boxes  of  goods,  etc.,  and  give  you  an  inventory,  or 
an  approximate  inventory,  of  my  stock,  then  I  am  making 
a  representation  as  to  an  existing  fact;  and  if  these  state- 
ments are  false,  and  you  extend  credit  to  me  on  the 
strength  of  them,  I  come  within  the  law  against  obtaining 
money  under  false  pretenses. 

Opinion  Cannot  be  Construed  as  Misrepresentation 

But  such  representation  must  be  a  representation  as  to 
a  fact,  and  not  an  opinion.  If  I  represent  to  you  that  in 
my  store  I  have  certain  fixtures,  it  may  be  that  you  are  so 
situated  that  you  cannot  go  to  the  store  and  look  at  them, 
and  so  you  rely  on  my  representation;  and  if  I  have  mis- 
represented what  I  have  in  my  store,  I  have  made  a  mis- 
representation as  to  fact.  But  if,  on  the  other  hand,  I  tell 
you  that  the  goods  and  fixtures  which  I  have  in  my  store 
are  worth  $3,000,  when,  as  a  matter  of  fact,  in  the  mar- 
ket they  may  be  worth  only  $1,500,  I  am  not  misrepre- 
senting a  matter  of  fact  but  merely  stating  an  opinion. 

Take  another  example  that  will  illustrate  the  point  a 
little  better.  If  I  tell  you  I  own  a  lot  and  that  it  is  worth 
$2,500,  when  the  lot  can  really  be  bought  for  $1,600  or 
$1,800,  I  am  making  a  misrepresentation  as  to  opinion. 
In  my  opinion  it  may  be  that  the  lot  is  really  worth 
$2,500,  but  it  may  be  also  true  that  you  can  get  just  as 
good  a  lot  for  $1,600.  The  representation  which  I  have 
made  is  a  matter  of  opinion  for  which  I  cannot  be  prose- 
cuted, except  under  rare  circumstances.  If  I  represent  to 
you,  however,  that  I  am  the  owner  of  the  lot  when,  as  a 
matter  of  fact,  I  am  not,  or  if  I  represent  to  you  that 
the  lot  is  free  and  clear  when,  as  a  matter  of  fact,  I  have 


FRAUDS  185 

a  mortgage  on  the  lot,  I  am  making  a  misrepresentation 
as  to  a  fact  and  can  be  prosecuted. 

It  sometimes  happens,  however,  that  a  representa- 
tion as  to  a  matter  of  opinion  is  so  grossly  incorrect  that 
the  Court  will  declare  it  a  misrepresentation  as  to  fact, 
particularly  in  matters  involving  opinions  as  to  values. 
For  instance,  a  lot  in  some  little  suburb,  or  some  new  town 
that  exists  only  on  paper,  may  actually  be  worth  about 
$75.  Some  stranger  may  be  informed  that  that  lot  is 
worth  $10,000  or  $20,000.  The  courts  have  sometimes 
held  that  under  such  circumstances  the  person  who  made 
the  representation  could  not  have  honestly  entertained  the 
opinion  that  it  was  worth  two  or  three  hundred  times  its 
actual  value,  and  have  held  that  such  a  misrepresentation 
as  to  value  is  a  misrepresentation  as  to  opinion,  and  that 
the  purchaser  is  entitled  to  protection  against  misrepre- 
sentations of  such  character. 

The  business  man  must,  however,  for  the  most  part 
look  out  for  himself  in  such  matters  and  be  careful  to  ob- 
serve whether  a  misrepresentation  deals  with  facts  or 
with  opinions  and  whether  it  represents  facts  as  they  now 
exist,  or  have  existed  in  the  past,  not  as  they  may  be  in 
the  imagination  of  the  promoter  or  the  persons  engaged 
in  business,  and  not  as  they  may  exist  in  the  future. 

Statement  Must  be  Known  to  be  False  by  Maker 

The  person  who  makes  a  false  representation  must 
know  that  it  is  false  or  he  cannot  be  held  liable.  A  person 
who  innocently  makes  a  misrepresentation  is  guilty  of  no 
crime,  even  though  his  misrepresentation  may  result  in  a 
loss  to  others.  He  must  either  know  that  it  is  untrue,  or 
he  must  represent  something  as  true  of  his  own  knowl- 
edge, when,  as  a  matter  of  fact,  he  does  not  know  any- 
thing about  it.  Either  of  these  conditions  will  make  him 


186  MERCANTILE  CREDITS 

liable  under  the  law.  When  a  man  knows  his  statement 
is  false  it  can  usually  be  proved  by  showing  that  he  was 
familiar  with  the  subject,  and  in  a  position  to  know  if  he 
wanted  to.  As  a  rule,  the  law  presumes  that  men  are 
sane,  and  that,  if  they  are  in  a  position  where  they  ought 
to  know,  they  do  know. 

Intent  to  Defraud 

A  misrepresentation  must  be  made  with  intent  to  de- 
fraud. If  it  is  made  to  somebody  who  is  merely  inquiring 
into  your  business  affairs,  and  who,  as  you  think,  has  no 
business  to  inquire  into  them,  and  you  make  your  misrep- 
resentation to  him  only  with  the  intention  of  misleading 
him,  you  are  not  guilty  of  any  crime,  because  the  mis- 
representation must  be  made  with  the  intent  to  defraud. 

Creditor  Must  Rely  on  Misrepresentation 

There  still  remains  something  before  the  crime  of 
false  representation  can  be  established.  The  person  from 
whom  the  money  was  obtained  must  have  believed  the 
representations.  If  I  come  to  you  and  tell  you  that  I  am 
the  owner  of  the  lot  next  door,  and  you  know  that  some 
one  else  owns  it,  you  must  not  extend  credit  to  me  think- 
ing you  can  prosecute  me  criminally,  or  that  you  have  a 
criminal  hold  on  me.  You  know  better;  you  know  I  do 
not  own  it;  and  the  law  does  not  allow  you  to  hold  any- 
thing over  my  head.  You  must  believe  and  rely  on  the 
representation  that  is  made  to  you. 

Now,  by  relying  on  a  representation  that  is  made  to 
you,  I  do  not  mean  that  it  is  necessary  that  you  should 
abstain  from  making  any  investigation  into  what  has  been 
told  you.  That  would  be  a  foolish  requirement,  because 
you  might  be  deceived  in  making  your  investigations. 
You  might  have  relied  in  part  on  your  investigations,  and 


FRAUDS  187 

in  part  on  what  was  said  to  you.  If  you  relied  in  any 
part  upon  what  was  said  to  you,  and  if  you  are  primarily 
induced  by  what  was  said  to  you,  and  these  other  investi- 
gations which  you  made  merely  verified  such  statements, 
and  caused  you  to  rely  upon  them,  then  you  have  not  lost 
your  remedy — you  can  still  prosecute  for  obtaining  money 
under  false  pretenses ;  but  remember  always  that  you  must 
rely  on  what  is  represented  to  you  before  you  can  prose- 
cute criminally.  You  must  not  close  your  eyes  to  those 
things  which  you  know  to  be  untrue. 

If  you  have  business  dealings  with  a  man  whom  you 
find  to  be  a  liar,  no  matter  what  his  assets  are,  no  matter 
what  clubs  you  hold  over  his  head,  you  had  better  drop 
such  a  customer  at  once.  I  am  sure  that  those  who  have 
had  experience  in  credit  work  will  corroborate  me  in  this. 
That,  however,  is  a  phase  of  the  subject  that  is  outside  the 
field  with  which  we  are  dealing.  I  only  mention  it  inci- 
dentally in  discussing  the  question  of  your  reliance  on 
what  the  other  person  has  told  you  when  you  extend 
money  or  credit  to  him. 

Silence  is  Not  False  Representation 

Now,  there  is  another  class  of  cases  in  which  the 
person  deceives  himself,  or,  while  he  thinks  he  is  acting 
upon  representations  or  pretenses  that  are  made  by  the 
other  party  to  the  transaction,  does  not  really  do  so  be- 
cause the  other  party  merely  remains  silent.  Of  course, 
where  it  is  the  duty  of  one  to  disclose  a  fact,  and  he  fails 
to  do  it,  it  constitutes  fraud  or  deceit  on  his  part;  but  the 
law  leaves  those  cases  to  the  civil  courts,  and  frequently 
you  have  not  even  a  remedy  in  civil  law  because  of  the 
old  rule  caveat  emptor — "let  the  buyer  beware."  For 
instance,  if  you  had  a  horse  in  your  possession,  and  I 
looked  at  the  horse  and  admired  it  and  asked  how  much 


188  MERCANTILE  CREDITS 

you  wanted  for  it,  and  you  said  $100  and  I  paid  you  for 
the  horse  and  went  away  with  it,  I  would  have  no  remedy, 
even  if  it  developed  that  the  horse  had  many  faults,  for 
you  made  no  representations  to  me  whatever.  It  was  my 
business  to  make  an  investigation — to  inquire  from  you, 
or  examine  the  horse.  The  law  does  not  attempt  in  all 
cases  to  guard  against  ignorance  or  carelessness.  It  only 
attempts  to  guard  against  those  things  which  you  cannot 
guard  against  yourself;  that  is,  to  guard  against  the  un- 
truthfulness  and  the  misrepresentations  of  others.  It 
protects  you  when  you  use  that  care  and  caution  which  you 
should  use,  and  the  man  who  would  buy  a  horse  without 
proper  -precautions  in  the  manner  described,  could  not 
proceed  in  any  way  against  the  person  from  whom  he 
bought  the  horse. 

Corroborative  Evidence  Necessary 

There  is  another  thing  that  I  want  to  discuss  before 
we  leave  the  subject  of  obtaining  money  under  false  pre- 
tenses, and  that  is  the  evidence  by  which  a  false  pretense 
is  proved.  If  a  man  has  done  the  fraudulent  things  to 
which  I  have  called  your  attention,  he  is  guilty  of  obtain- 
ing money  under  false  pretenses.  But  the  other  day  in 
court  I  went  down  to  hold  a  preliminary  examination  in  a 
case  where  a  man  had  been  accused  of  doing  these  things. 
The  prosecuting  witness  testified  absolutely  to  every  fact 
necessary  to  constitute  that  crime;  and  if  the  prosecuting 
witness  was  telling  the  truth,  as  I  believe  he  was,  there 
was  no  doubt  that  that  crime  was  committed,  but  I  had  to 
dismiss  the  case  at  once.  Why?  Because  when  I  asked 
him  who  was  present,  he  had  to  answer,  "No  one."  Then 
I  asked,  "Did  you  have  any  written  memorandum  con- 
cerning this  transaction?"  "No,"  he  replied,  "I  didn't 
have  anything  in  writing  saying  that  the  defendant  had 


FRAUDS  189 

made  these  representations."  I  said,  "What  other  cir- 
cumstances are  there  that  will  corroborate  your  state- 
ment?" "I  don't  know  of  any  other,"  was  the  answer. 
He  was  accompanied  by  an  attorney  who  should  have 
known  better.  I  asked  him,  "What  do  you  rely  on  to 
corroborate  this  man's  statement?"  He  replied,  "We  are 
here  to  show  that  the  other  man  is  a  liar."  I  said,  "You 
can't  do  it.  You  have  to  corroborate  your  client's  state- 
ments before  you  can  make  a  claim  of  false  representa- 
tion." So  I  had  to  dismiss  the  case,  although  the  man 
accused  may  have  been  guilty  of  a  crime. 

Before  you  can  prosecute  a  man  for  making  false  pre- 
tenses, you  must  either  have  two  witnesses  to  the  trans- 
action; which  may  be  yourself  and  some  one  else;  or,  you 
must  have  some  representation  in  writing  to  corroborate 
your  statement — which  is  known  in  law  as  a  false  token — 
or  else  some  other  circumstance  tending  to  prove  that  the 
misrepresentation  was  actually  made. 

Written  Evidence 

As  an  instance  of  written  evidence,  I  go  to  a  money 
lender  and  borrow  some  money  on  a  personal  mortgage, 
or  give  a  mortgage  on  personal  property.  I  represent  to 
him  that  I  am  the  sole  owner  of  that  property,  and  that 
it  is  free  and  unencumbered.  Usually  money  lenders  put 
this  phrase  in  their  chattel  mortgages:  "The  mortgagor 
hereby  declares  that  he  is  the  sole  owner  of  the  above 
described  personal  property,  and  that  it  is  free  and  clear 
of  all  encumbrances."  Right  there  you  have  a  memor- 
andum corroborating  what  the  mortgagor  has  said  to  the 
mortgagee;  and  if  the  representation  proves  untrue,  the 
mortgagee  can  prosecute  even  though  no  special  witnesses 
were  present,  because  he  has  the  mortgagor's  own  state- 
ment and  the  memorandum  corroborating  his  statement 
to  prove  that  the  false  pretense  was  made. 


190 


MERCANTILE  CREDITS 


Corroborating  Circumstances 

False  pretenses  may  sometimes  be  proved  by  cor- 
roborating circumstances,  but  this  method  of  proof  is  not 
frequent,  because  the  man  who  commits  the  crime  of 
obtaining  money  under  false  pretenses  does  not,  as  a  rule, 
do  any  other  corroborative  act;  he  does  not  allow  any 
other  circumstance  to  be  created  which  will  corroborate 
His  victim's  testimony,  if  the  victim  sees  fit  to  prosecute. 
It  sometimes  happens,  though,  that  a  man  follows  a  cer- 
tain course  of  criminal  conduct  which  enables  the  prose- 
cutor to  introduce  corroborating  circumstances  of  suffi- 
cient weight  to  convict  him. 

Value  of  Financial  Statements 

As  to  the  credit  man,  however,  the  best  thing  to  do 
when  a  man  applies  to  him  for  credit,  is  to  have  him  make 
in  writing  a  statement  of  what  his  assets  and  liabilities 
are.  The  important  point  is  not  the  value  of  the  assets, 
because  that  is  a  matter  of  opinion  which  ultimately  you 
will  have  to  determine  for  yourself,  but  the  statement  of 
fact  as  to  what  he  actually  owns  and  what  he  actually 
owes.  What  a  man  owes  another  is  a  question  of  fact; 
and  if  I  owe  you  $100,  my  opinion  as  to  whether  it  is 
more  or  less  than  $100  will  not  change  the  fact  that  it  is 
$100.  The  nature  of  the  customer's  actual  assets,  and 
whether  or  not  they  are  encumbered,  are  also  questions 
of  fact;  and  if  you  get  both  these  statements,  you  have 
something  that  you  can  use.  Banks  usually  require  such  a 
statement  from  those  desiring  to  borrow  money,  unless 
the  customer  happens  to  be  one  with  whom  they  are  so 
well  acquainted  that  they  feel  it  unnecessary  to  be  on  their 
guard. 

There  is  another  reason  for  requiring  written  state- 
ments, besides  the  fact  that  they  will  be  legal  evidence. 


FRAUDS 


191 


The  man  who  is  making  a  false  statement  will  not  put  it  in 
writing  if  he  can  help  it;  and  if  you  request  him  to  do  so, 
he  will  temper  it  down  to  the  facts,  and  will  not  attempt 
to  exaggerate  his  assets  so  much  and  thus  you  will  get  at 
the  truth.  Business  men  do  not  want  lawsuits;  but  they 
do  want  good,  safe,  reliable  business.  Business  that  is 
not  safe  and  reliable,  may  compel  the  creditor  to  resort  to 
the  prosecuting  attorney's  office,  or  to  the  employment  of 
private  attorneys — a  kind  of  business  not  often  profitable. 
Of  course,  a  business  man  should  know  the  law,  and 
should  know  what  to  do  if  he  has  made  a  mistake  in 
judgment,  and  what  legal  method  he  can  employ  to  guard 
against  the  crook  and  the  dishonest  man;  but  he  does  not 
want  to  get  into  a  lawsuit  if  there  is  any  proper  way  by 
which  it  can  be  avoided. 

The  Defrauded  Person  Not  Always  Blameless 

Captain  Fredericks,  District  Attorney  of  Los  Angeles, 
recently  prepared  some  notes  on  the  subject  of  frauds 
which  I  think  contain  very  sound  advice  for  the  business 
man,  and  are  therefore  quoted  here  in  part. 

"It  is  very  rare  indeed  that  a  man  is  deceived  by  an- 
other, and  parts  with  property,  without  having  a  criminal 
or  a  civil  remedy,  unless  he,  himself,  has  been  endeavor- 
ing to  get  too  much  the  best  of  the  bargain.  For  instance, 
no  man  would  pay  one  hundred  dollars  for  a  horse  with- 
out asking  the  seller  all  sorts  of  questions  which,  if  an- 
swered untruthfully,  would  be  the  basis  of  a  criminal  or 
civil  action,  unless  he,  the  purchaser,  believed  he  was  get- 
ting so  much  the  best  of  the  bargain  that  he  feared  to 
endanger  the  trade  by  too  much  bargaining.  In  such  a 
case  if  he  gets  the  worst  of  the  bargain,  he  is  punished 
by  reason  of  his  own  avarice  and  selfishness,  and  deserves 
what  he  gets." 


I92  MERCANTILE  CREDITS 

Self -Deception 

"Men  in  business  must  learn  the  difference  between 
deceiving  themselves  and  permitting  others  to  deceive 
them.  It  is  a  fact  that  a  man  can  deceive  himself  more 
easily  than  he  can  deceive  any  one  else.  Many  of  the 
cases  involving  fraud  and  deceit  which  get  into  the  civil 
and  criminal  courts  arise  from  the  fact  that  the  man  who 
has  suffered  has  deceived  himself,  or  has  not  taken  that 
care  or  made  that  inquiry  which  the  law  and  ordinary 
prudence  require. 

"There  has  been  no  thought  more  frequently  and 
thoroughly  impressed  on  my  mind  in  the  years  I  have  had 
intimate  knowledge  with  the  sordid  side  of  life  than  the 
thought  expressed  so  aptly  by  Pope, 

'All  is  infected  that  the  infected  spy, 

As  all  looks  yellow  to  the  jaundiced  eye.' 

meaning  that  we  often  deceive  ourselves  into  seeing  what 
we  are  looking  for,  even  though  it  may  not  exist/' 

This  is  just  what  we  must  bear  in  mind  in  securing 
business.  We  must  not  deceive  ourselves  into  believing 
that  a  man  is  a  good  customer  when  he  is  not. 

Prudent  and  Imprudent  Investment 

"To  illustrate  the  safe  and  the  unsafe  method  of  pro- 
cedure in  financial  matters,  I  will  describe  two  different 
methods  of  investing  in  an  enterprise  which  is  intrinsically 
good  but  undeveloped. 

"First.  The  reckless  financier  will  put  money  and 
effort  into  an  enterprise  although  he  knows  there  is  no 
hope  of  success  unless  others  afterwards  buy  stock,  or  put 
in  money,  and  that,  if  for  any  reason  this  should  fail  to 
take  place,  all  that  was  originally  invested  would  be  lost. 

"Second.     The   safe   financier   agrees  to   invest  his 


FRAUDS  193 

money  only  when  sufficient  capital  has  been  subscribed  to 
fully  finance  the  undertaking,  including  all  possible  acci- 
dents and  incidents.  He  considers  the  entire  course  to  be 
traveled,  and  all  the  expenses  necessary  to  be  incurred — 
probably  with  the  aid  of  experts,  and  after  determining 
just  what  capital  will  be  necessary  to  make  all  payments 
and  cover  all  contingencies,  he  sets  that  amount  as  the 
mark  which  must  be  raised  before  he  parts  with  any  of 
his  money. 

"Now  suppose  both  these  imaginary  undertakings  fail, 
and  the  money  invested  is  lost.  Who  is  to  blame  for  the 
fact  that  the  first  and  the  second  men  put  their  money  into 
the  undertakings  and  lost  it?  The  first  man,  to  begin 
with,  simply  gambled  on  the  probability  of  future  hap- 
penings, or  did  not  make  sufficient  investigation  to  know 
upon  what  contingency  success  depended.  Probably  no 
one  deceived  him.  He  did  not  give  any  one  a  chance  to 
deceive  him.  He  thought  he  saw  a  chance  for  large  re- 
wards, and  deceived  himself.  He  is  the  one  who  requires 
the  services  of  a  guardian. 

"In  the  second  instance,  however,  the  investor  has 
eliminated  chances  to  a  large  extent;  and  when  the  enter- 
prise fails,  he  is  in  a  position  to  hold  some  one  civilly  or 
criminally  liable — criminally  liable  if  he  has  relied  upon  a 
false  statement  made  to  him  in  his  investigation  prior  to 
investment,  and  civilly  liable  in  any  other  case. 

"The  first  investor  comes  to  the  authorities  in  mad 
haste,  and  endeavors  to  use  the  criminal  law  in  order  to 
extort  his  money  from  some  one  who  would  rather  pay 
than  be  prosecuted.  I  do  not  think  that  he  does  this 
always  viciously,  but  as  a  rule  thoughtlessly.  He  merely 
wants  to  get  his  money  back,  and  is  very  much  disap- 
pointed when  the  district  attorney  will  not  prosecute 
under  the  circumstances. 


I94  MERCANTILE  CREDITS 

"The  second  investor  has  not  deceived  himself,  and 
if  his  enterprise  fails,  he  has  some  one  upon  whom  he 
can  rely,  or  upon  whom  he  did  rely,  rather;  and  when  he 
comes  to  the  district  attorney  he  has  a  case." 

And  that  is  the  class  in  which  you  should  always  en- 
deavor to  be.  If,  for  any  reason,  you,  or  the  firm  or  cor- 
poration with  which  you  are  connected,  has  been  deceived 
or  cheated,  let  it  be  not  a  case  of  self-deception,  not  a  case 
of  carelessness  on  your  part,  but  a  case  where  you  had  to 
rely  and  did  rely  on  representations  which  were  know- 
ingly, not  thoughtlessly,  made  to  you  by  the  person  with 
whom  you  were  dealing.  Then  in  that  case  a  prosecution 
can  be  instituted  in  the  criminal  courts,  and,  if  there  are 
any  assets  at  all,  you  can  prosecute  successfully  a  civil 
action  for  the  recovery  of  your  money. 

It  is  the  duty  of  the  district  attorney  to  prosecute 
criminals,  but  it  is  not  his  duty  to  run  a  collection  agency. 
Most  men  who  have  committed  crime,  if  they  themselves 
lack  the  funds,  have  friends  or  relatives  who  are  willing 
to  come  to  the  rescue,  and  put  up  money  to  stop  a  prosecu- 
tion if  the  district  attorney's  office  can  be  used  in  that  way. 
But  remember  that  this  is  not  the  duty  of  the  district  at- 
torney; and  the  ordinary  district  attorney  objects  to  being 
used  as  a  collection  agency,  and  will  refuse  to  be  so  used. 
When  you  attempt  to  compromise  a  crime,  to  dismiss  a 
case  once  instituted,  on  recovery  of  your  money,  you  are 
either  compounding  a  felony  or  a  misdemeanor,  or  you 
are  guilty  of  extortion.  A  man  who  tries  to  use  the  dis- 
trict attorney's  office  even  to  collect  a  just  debt  is  guilty 
of  extortion,  and  he  cannot,  when  charged  with  extortion, 
set  up  as  a  defense  that  the  money  he  was  trying  to  collect 
was  really  owing  to  him.  This  is  something  that  is  not 
realized  by  those  who  attempt  to  use  the  district  attor- 
ney's office  in  this  way,  but  it  is  the  case  nevertheless. 


FRAUDS  195 

Summary 

You  'must  use  every  effort  to  protect  yourself  from 
fraud;  investigate  with  care,  and  then  use  your  own  best 
judgment.  You  should  understand  the  law  in  order  to 
know  when  a  man  who  has  violated  it  may  be  prosecuted, 
so  as  to  deter  him  and  others  from  committing  like  crimes 
in  the  future.  When  you  have  been  cheated  or  defrauded 
to  the  violation  of  the  criminal  law,  you  ought  to  prose- 
cute relentlessly,  even  if  your  prosecution  results  in  some 
temporary  financial  loss  to  yourself.  If  credit  men  in 
general  will  do  this — will  let  the  criminally  inclined  know 
that  money  is  no  object  to  them  when  those  with  whom 
they  are  dealing  have  violated  the  law  of  fraud — the  prac- 
tice of  obtaining  money  or  goods  under  false  pretenses 
will  cease  very  soon,  and  the  district  attorney's  office  will 
no  longer  be  needed  as  a  collection  agency. 


CHAPTER  XI 

AMICABLE  ADJUSTMENT  WITH  INSOLVENT 
DEBTORS 

BY  F.  C.  DELANO 

Advantages  of  Amicable  Adjustment 

The  "Amicable  Adjustment"  is  the  peaceable,  friendly 
adjustment  between  debtor  and  creditors  by  which  the 
best  results  for  both  are  obtained,  and  this  without  litiga- 
tion, for  litigation  is  legal  warfare,  and  war  is — expense ! 
Its  superiority  to  all  other  methods  is  shown,  first,  in  the 
reduced  cost  of  handling  estates;  next,  in  the  shorter  time 
involved  in  settling  with  the  creditors ;  and  last,  but  not 
least,  in  the  larger  amounts  paid  to  the  creditors.  Of 
these  three  matters  we  will  speak  later. 

California  Boards  of  Trade 

In  the  matter  of  amicable  adjustments  the  West  has 
taken  a  leading  part.  For  many  years  the  wholesale 
merchants  of  California  have  been  adjusting  their  losses 
and  liquidating  the  estates  of  insolvent  debtors  through 
the  medium  of  adjustment  bureaus,  the  principal  ones  be- 
ing the  Board  of  Trade  of  San  Francisco  and  the  Los 
Angeles  Wholesalers  Board  of  Trade.  The  Board  of 
Trade  of  San  Francisco  was  organized  in  1877,  and  has  a 
present  membership  of  218,  handling  an  annual  volume 
of  business  amounting  to  more  than  $700,000.  The  Los 
Angeles  Wholesalers  Board  of  Trade  has  a  membership 


ADJUSTMENT  WITH  DEBTORS  197 

of  135,  with  receipts  and  disbursements  in  1912  of  more 
than  $500,000. 

These  two  organizations  are  mentioned  as  prominent 
examples  of  the  growth  of  the  adjustment  idea ;  and  the 
fact  of  their  continued  existence  and  the  steady,  un- 
solicited increase  in  their  membership  would  seem  to  be 
sufficient  evidence  that  the  majority  of  the  wholesale  mer- 
chants of  these  two  cities  have  realized,  and  are  profiting 
by,  the  advantages  of  the  adjustment  bureau. 

Increase  of  Adjustment  Bureaus 

Adjustment  bureaus  everywhere  are  growing  in  num- 
bers and  in  strength.  The  larger  business  centers  west  of 
the  Rocky  Mountains,  such  as  Salt  Lake  City,  Denver, 
Spokane — and  even  small  towns  like  San  Diego — have 
adjustment  bureaus  in  successful  operation,  handling 
practically  75  per  cent  of  all  the  business  failures.  The 
larger  Eastern  cities,  also,  are  realizing  the  importance 
of  co-operation,  and  are  organizing  for  the  purpose  of 
settling  cases  of  insolvency  out  of  court  by  liquidation  or 
otherwise;  though  it  is  safe  to  say  that  less  than  25  per 
cent  of  their  failures  are  settled  through  the  adjustment 
bureau. 

Credit  Associations 

In  the  East  the  various  lines  of  trade  have  their  own 
associations,  taking  over  and  handling  adjustments  in 
their  own  lines  of  business.  Such  are  the  Manufacturing 
Jewelers  Board  of  Trade  of  Providence;  the  Shoe  and 
Leather  Board  of  Trade  of  Boston;  the  National 
Clothiers  Association  of  New  York;  and  the  National 
Jewelers  Board  of  Trade,  with  headquarters  in  New 
York  and  local  secretaries  in  all  the  large  cities.  But  the 
greatest  co-operative  association  of  this  kind  in  the  busi- 


I98  MERCANTILE  CREDITS 

ness  world  is  the  National  Association  of  Credit  Men, 
organized  about  eighteen  years  ago,  and  now  having  a 
membership  of  over  16,000,  with  more  than  80  affiliated 
local  branches,  and  with  45  bureaus  for  the  exchange  of 
credit  information  and  for  the  adjustment  of  insolvent 
estates. 

Economy  of  Adjustments 

Now,  what  is  the  meaning  of  all  this?  It  is  simply  a 
part  of  the  forward  movement,  world-wide  in  extent,  to 
stop  economic  waste.  Great  combinations  of  capital  with 
the  latest  and  most  improved  machinery,  utilizing  all  the 
forces  of  nature,  are  striving  for  the  maximum  of  pro- 
duction with  the  minimum  of  cost;  but  it  has  been  left  to 
the  credit  men  of  the  extreme  West  to  teach  the  whole- 
sale merchants  of  the  entire  nation  the  art  of  conserving 
their  credits — their  debtor's  assets — and  of  saving  to 
their  own  commercial  houses  the  greater  portion  of  that 
waste  which  has  heretofore  been  eaten  up  by  courts  of 
equity,  attorneys'  fees,  and  other  useless  expenses.  All 
this  is  accomplished  by  the  amicable  adjustment  with 
failed  debtors. 

Adjustment  Procedure 

When  a  debtor  fails,  you  are  advised  of  the  fact  by 
the  mercantile  agencies,  by  your  salesman,  or  by  some 
other  creditor;  or  perhaps  your  first  notification  is  when 
the  telephone  rings,  and  you  are  asked  to  attend  a  meet- 
ing at  the  "Board  of  Trade."  Such  a  meeting,  however, 
does  not  always  mean  a  failure;  for  sometimes,  when  a 
debtor  is  given  an  extension  of  time  and  helped  along  a 
little  by  his  creditors,  he  pays  them  in  full  and  continues 
to  be  a  good  customer,  often  discounting  his  bills. 

On  the  other  hand,  it  frequently  happens  that  an 


ADJUSTMENT  WITH  DEBTORS  199 

individual  who  fails  to  recognize  any  moral  obligation 
to  his  fellow  creditors,  will  levy  an  attachment  on  a 
debtor's  place  of  business,  place  a  deputy  sheriff  in  charge, 
close  the  store,  and  not  only  injure  the  debtor's  trade,  but 
run  up  a  bill  of  expense  that  is  part  of  the  great  waste  he 
should  be  seeking  to  avoid.  Sometimes,  also,  a  debtor, 
poorly  advised  by  some  attorney  who  has  a  higher  re- 
gard for  fees  than  for  the  welfare  of  his  client,  evades  his 
creditors  and  procures  a  coat  of  whitewash  in  the  bank- 
ruptcy court. 

] 
Consulting  with  Creditors 

When  a  man's  place  of  business  is  attached,  or  when 
he  is  in  financial  distress,  his  wisest  course  is  to  consult  his 
heaviest  creditors.  If  they  are  unable  to  help  him  over 
his  immediate  difficulties,  a  meeting  of  creditors  should 
be  called  at  once.  Sometimes  a  meeting  is  called  by  a 
creditor  who  has  heard  something  of  the  debtor's 
troubles,  financial  or  otherwise;  sometimes  by  one  who 
knows  nothing  of  the  debtor's  difficulties  except  that  he 
has  been  unable  to  collect  his  own  account.  These  meet- 
ings are  held  at  various  places,  sometimes  at  the  office  of 
the  debtor's  attorney,  occasionally  at  the  debtor's  place 
of  business,  but  generally  at  the  office  of  some  creditor,  or 
at  the  office  of  the  adjustment  bureau. 

When  a  debtor  calls  a  meeting  of  his  creditors,  it  is 
almost  certain  that  he  has  reached  the  end  of  his  rope, 
and  wishes  to  place  his  affairs  in  their  hands,  allowing 
them  to  adjust  them  as  best  they  can,  and  hoping  that 
they  will  be  satisfied  to  give  him  a  release.  Sometimes 
the  debtor  demands  this  release  as  a  consideration  for  his 
making  an  assignment,  or  a  transfer  of  his  assets;  some- 
times he  overlooks  this  request,  and  it  is  granted  to  him 
voluntarily  by  his  creditors;  and  sometimes,  yielding  to 


200  MERCANTILE  CREDITS 

the  demand  of  certain  creditors — a  demand  not  often 
made — debtors  will  make  an  assignment  or  a  transfer  of 
their  entire  assets,  and  give  their  personal  note  for  the 
deficiency.  These  notes  are  usually  payable  on  demand,  or 
at  some  specified  time,  without  the  slightest  idea  of  how 
or  when  they  can  meet  these  promises. 

The  Debtor's  Attorney 

If  a  meeting  is  called  by  the  debtor's  attorney,  there 
are  several  things  to  be  considered.  The  attorney  has 
generally  gone  over  the  debtor's  affairs  very  carefully, 
and  being  fully  advised  as  to  his  client's  condition,  will 
now  ask  that  he  be  granted  an  extension  of  time  in  which 
to  meet  his  obligations;  or  will  suggest  a  composition 
settlement  at  so  much  on  the  dollar,  ranging  anywhere 
from  25  to  50  per  cent;  or  will  state  that  the  debtor  can- 
not continue  the  business,  and  is  willing  to  transfer  every- 
thing to  the  creditors,  providing  they  will  release  him 
from  all  obligations.  In  this  last  case  he  generally  insists 
on  the  further  provision  that  the  debtor  be  allowed  to  re- 
tain such  of  his  personal  or  real  property  as  may  be 
exempt  from  execution  or  subject  to  homestead  rights. 

Unscrupulous  Debtors  and  Attorneys 

I  am  here  speaking  only  of  reputable  attorneys.  But 
sometimes  we  have  to  deal  with  a  crooked  debtor  or  a 
more  crooked  attorney — more  crooked  because  he  is  more 
experienced  and  more  able — and  in  such  a  case  the  credi- 
tors will  often  accept  the  proposition  outlined  by  the 
attorney,  even  though  it  may  be  very  unsatisfactory  to 
them.  They  do  this  because  they  know,  or  at  least  they 
fear,  that  the  attorney  has  carefully  planned  to  prevent 
their  obtaining  any  more  under  bankruptcy  than  the 
debtor  is  offering  through  this  settlement. 


ADJUSTMENT  WITH  DEBTORS  201 

But  the  best  laid  plans  of  crooks  and  their  attorneys 
may  sometimes  fail.  For  instance,  we  had  a  case  in  a 
neighboring  town  some  two  years  ago  which  had  all  the 
appearance  of  being  a  carefully  planned  fraud.  We  will 
say  that  the  party's  name  was  Brown.  The  business  had 
been  conducted  in  the  name  of  "A.  Brown"  for  a  great 
many  years;  and  it  was  generally  understood  that  UA. 
Brown"  meant  Adam  Brown;  but  as  a  matter  of  fact,  it 
meant  Anna  Brown.  In  addition  to  the  business,  Mrs. 
Anna  Brown  owned  considerable  real  estate,  good  prop- 
erty, and  was  responsible  in  every  way.  The  business, 
however,  got  into  a  shaky  condition  and  Mrs.  Anna 
Brown,  with  the  aid  of  a  certain  attorney  of  Los  Angeles, 
conceived  the  idea  of  incorporating  it.  She  transferred 
her  stock  of  merchandise  for  the  full  amount  of  the  capi- 
tal stock  of  the  corporation,  and  then,  in  addition,  took 
a  note  for  $25,000  for  the  "good-will"  of  the  business, 
and  afterward  transferred  her  stock  to  Adam  Brown, 
who  had  no  property.  Had  the  concern  gone  into  bank- 
ruptcy six  months  afterwards,  Mrs.  Brown  would  have 
been  the  largest  creditor;  but  the  real  facts  were  by  acci- 
dent discovered  sooner,  and,  instead  of  collecting  from  the 
bankrupt  concern,  Mrs.  Brown  was  compelled  to  give  a 
trust  deed  on  about  $20,000  of  real  estate  to  meet  its 
liabilities.  This  broke  up  the  combination. 

The  Creditors'  Meeting 

Nearly  all  the  adjustment  bureaus  now  maintain 
credit  departments  where  may  be  found  reports  on  hun- 
dreds or  thousands  of  debtors  who  are  slow  pay,  or  who 
are  not  in  the  habit  of  discounting.  From  these  reports, 
if  the  debtor's  name  is  included,  a  fairly  accurate  list  of 
the  various  wholesale  houses  that  he  is  owing  may  be 
obtained.  If  no  such  report  is  available,  and  if  the 


202  MERCANTILE  CREDITS 

creditor  asking  for  the  meeting  has  no  list  of  creditors, 
he  will  secure  a  partial  list  by  telephone  and  invite  all  the 
local  creditors  known  to  him  to  attend  a  meeting.  If  it 
is  possible,  the  debtor  will  also  be  requested  to  attend. 

Methods  of  Settlement 

Generally  speaking,  only  four  methods  of  settlement 
are  possible:  extension  of  time,  with  or  without  security; 
composition  settlement;  assignment,  with  or  without  re- 
lease; and  bankruptcy,  voluntary  or  involuntary. 

Information  Required 

It  is  necessary,  of  course,  before  settling  with  a 
debtor,  that  his  creditors  should  obtain  as  full  and  com- 
plete information  regarding  his  affairs  as  possible.  The 
first  question  they  will  ask  is,  "How  much  do  you  owe?" 
Next,  they  will  want  to  know  the  amount  of  assets  in  de- 
tail, the  value  of  fixtures,  whether  the  fixtures  are  owned 
or  leased,  clear  or  mortgaged,  or  being  purchased  on  con- 
ditional sales  contract;  and  finally  the  amount  of  cash  on 
hand  or  in  the  bank. 

You  will  invariably  find  the  cash  on  hand  to  be  the 
only  asset  that  will  not  shrink  in  value  before  you  get 
through — just  the  real  hard  cash  in  the  cash  drawer  or 
in  the  bank.  And  even  the  cash  in  bank  will  not  be  worth 
one  hundred  cents  on  the  dollar  if  the  bank  holds  a  note 
that  is  due  (and  most  bank  notes  are  due  in  a  crisis  like 
this),  for  the  law  gives  this  creditor,  the  bank,  the  right 
to  seize  the  debtor's  money  on  deposit  and  apply  it  on 
his  note. 

Then  the  creditors  will  ask  for  the  amount  of  the 
book  accounts  that  are  good,  the  value  of  wagons,  horses, 
and  other  live  stock,  the  amount  of  insurance  carried, 
the  amount  of  business  the  debtor  has  been  doing  for  the 


ADJUSTMENT  WITH  DEBTORS  203 

past  month  or  year,  the  margin  of  profit  he  is  making, 
and  so  on.  Then  they  will  want  to  know  the  ratio  be- 
tween his  gross  profit  and  his  expense,  and  from  these 
figures  they  will  judge  the  probability  of  his  paying  in  full 
if  allowed  to  continue  in  business. 


The  Business  Doctor 

The  debtor  may  need  the  services  of  an  expert  in 
some  particular  line — a  man  who  would  now  be  called  a 
"business  doctor"  or  an  "efficiency  expert."  I  know  one 
man  who  well  deserves  this  title,  for  he  can  detect  the 
wastes  and  leaks  in  the  ordinary  retail  business  with  such 
accuracy  that  he  can  reorganize  the  entire  system,  and,  if 
conditions  are  normal,  put  the  business  upon  a  sound 
basis  so  that  soon  it  will  show  a  steady  and  healthy 
profit.  There  are  many  men  in  need  of  the  services  of  a 
good  business  doctor,  and  the  latter,  if  he  is  allowed  to 
prescribe  in  the  early  stages  of  trouble,  will  treat  his 
patient  with  pills  that  are  nicely  sugar  coated;  but  if  the 
patient  delays  too  long,  his  medicine  is  likely  to  be  very 
bitter,  and  he  may  in  the  end  furnish  another  job  for  the 
commercial  undertaker. 

I  can  probably  best  illustrate  this  point  by  the  case  of 
a  certain  grocer  who  got  into  trouble.  We  will  call  him 
John  Blank.  A  meeting  of  creditors  was  called,  and  the 
debtor  requested  an  extension.  This  was  refused  at  the 
time  by  the  creditors,  but  an  assignment  was  taken  and 
the  business  was  continued  with  a  competent  man  in 
charge.  The  debtor  had  been  in  business  six  years,  hav- 
ing lost  during  that  time  some  $12,000.  He  had  aver- 
aged nearly  $200  per  month  loss.  Starting  with  $6,000 
in  cash  of  his  own  money,  he  had  become  embarrassed, 
and  then  an  uncle  had  advanced  him  as  much  more.  Now 
it  was  all  gone.  In  ten  or  twelve  weeks,  however,  the 


204  MERCANTILE  CREDITS 

new  manager  stopped  some  of  the  losses,  changed  the 
system,  and  made  some  $995  profit.  The  creditors  then 
settled  with  the  debtor  at  75  cents  on  the  dollar.  The 
debtor  had  learned  how  to  stop  the  waste  in  his  own  busi- 
ness, and  he  still  continues  with  apparent  success. 

Details  of  Adjustment 

When  the  creditors  have  finished  their  examination 
of  the  debtor,  they  will  excuse  him  from  the  room,  while 
they  discuss  his  affairs  in  private;  and  if  the  debtor  is  not 
suspected  of  fraud,  they  will  consent  to  his  making  a 
transfer  of  the  assets,  and  will  relieve  him  of  his  obliga- 
tions. They  then  appoint  a  chairman  of  the  meeting,  and 
generally  delegate  to  a  committee  of  the  larger  creditors 
full  power  to  negotiate  with  the  debtor  for  the  assign- 
ment, or  for  an  extension,  or  for  a  composition  settlement 
— whichever  is  deemed  best. 

If  it  is  to  be  an  assignment,  the  papers  are  generally 
signed  at  once,  and  a  representative  of  the  creditors  ac- 
customed to  such  work  is  sent  to  take  possession  of  the 
store  and  all  other  assets,  to  take  an  inventory,  to  collect 
the  accounts,  see  that  the  place  is  kept  insured,  and  in 
every  other  way  protect  the  business  as  if  it  were  his  own. 
Then  the  report  of  the  adjuster,  or  man  in  charge  of  the 
business,  is  presented  to  the  creditors'  committee,  and  the 
assignee,  receiving  his  instructions  from  the  committee, 
proceeds  to  conduct  the  business,  or  to  settle  it,  or  to 
close  it  up,  or  to  move  the  business  into  a  warehouse,  or 
to  dispose  of  it  in  such  other  way  as  directed  by  the 
creditors'  committee. 

The  creditors'  committee  is  generally  composed  of  the 
three  largest  creditors — those  who  will  suffer  most  if 
there  is  any  loss;  therefore,  the  smaller  creditors,  know- 
ing these  conditions,  can  generally  feel  that  their  interests 


ADJUSTMENT  WITH  DEBTORS  205 

are  well  protected,  because  the  larger  creditors  will  surely 
look  out  for  their  own. 

Continuing  the  Business 

If  the  creditors'  committee  decides  to  continue  the 
business  as  a  going  concern,  it  will  be  necessary  to  pur- 
chase goods  and  do  all  the  other  things  required  to  run 
the  business.  If  goods  are  to  be  purchased  in  the  name 
of  the  assignee,  the  buying  should  be  confined  to  those 
houses  which  are  already  interested,  but  only  on  the  con- 
dition that  the  prices,  delivery,  and  quality  of  the  goods 
are  equal  to  those  which  may  be  obtained  elsewhere.  This 
should  be  watched  very  carefully,  for  I  have  often  known 
creditors  to  raise  the  price  of  their  wares  as  soon  as  they 
felt  that  the  assignee  was  compelled  to  purchase  his  goods 
from  them. 

Selling  the  Business 

If  the  business  is  to  be  sold  as  a  going  concern,  or  is 
to  be  closed  immediately  and  sold  after  inventory,  the 
sale  may  be  conducted  in  several  different  ways;  some- 
times even  by  the  professional  auctioneer,  although  we 
have  never  had  very  much  success  with  this.  Sometimes 
the  assignee  holds  a  public  sale — or  we  might  term  it  a 
private  auction — to  which  he  invites  all  professional 
buyers  and  others  who  may  be  in  any  way  interested,  or 
are  likely  to  buy.  Public  notice  is  generally  given  through 
the  classified  advertising  in  the  daily  newspapers  under 
the  head  of  "Business  Chances"  or  "Auction."  Some- 
times these  sales  are  handled  exclusively  over  the  tele- 
phone, or  by  the  adjuster  in  charge,  the  different  offers  or 
bids  made  by  the  buyers  being  submitted  by  the  assignee 
to  the  creditors'  committee  for  its  approval. 

Generally  the  assignee  demands  cash  payment  on  the 


206  MERCANTILE  CREDITS 

sale  of  the  assets,  but  occasionally  he  will  be  instructed 
by  the  committee  to  accept  the  note  of  the  buyer.  This  is 
rarely  done,  however,  for  the  reason  that  the  creditors 
have  already  been  without  the  use  of  the  money  repre- 
sented by  their  interest  in  this  estate  for  a  long  time ;  and 
they  are  usually  eager  to  have  the  assets  converted  into 
cash.  Of  course  they  are  entitled  to  this;  but  it  is  often 
hard  to  find  a  buyer  who  is  able  or  willing  to  give  as 
much  as  the  committee  believes  the  merchandise  is  worth, 
and  it  may  be  necessary  to  give  him  some  time  in  which 
to  raise  the  full  amount  of  the  purchase  price.  When- 
ever this  is  done,  the  purchaser  should  give  security,  or  a 
guaranty  of  some  kind,  to  the  creditors. 

Preliminaries  of  Adjustment 

The  adjuster  in  charge  of  the  case,  first  sends  to  the 
assignee  a  full  list  of  the  creditors ;  then  he  takes  a  com- 
plete inventory,  and  cleans  up  the  stock  and  the  entire 
store.  He  gives  the  assignee  a  list  of  all  the  accounts 
receivable,  making  such  collections  as  are  possible  while 
in  charge  of  the  store,  and  assures  all  small  or  local  credi- 
tors that  the  assignment  is  for  the  mutual  benefit  of  all 
the  creditors,  trying  to  persuade  them  not  to  attach  by 
advising  them  that  such  an  act  would  increase  the  expense 
and  materially  lessen  their  recoveries — for  bankruptcy 
will  most  likely  follow  if  any  creditor  attempts  to  force  a 
settlement  of  his  claim  in  any  manner  by  which  he  obtains 
a  preference  at  the  expense  of  the  others. 

Creditors  Must  Cooperate 

We  had  a  case  only  last  week  where  a  man  who  was 
in  debt  about  $1,600,  with  assets  of  about  $1,800,  made 
an  assignment  for  the  benefit  of  creditors.  Two  small 
creditors,  having  claims  aggregating  less  than  $100, 


ADJUSTMENT  WITH  DEBTORS  207 

attached.  They  were  frank  to  say  that  they  believed  that 
the  other  creditors  would  allow  them  to  be  paid  in  full, 
and  tried  to  bluff  it  out;  but  it  did  not  work  that  way.  The 
creditors  held  a  meeting,  called  the  debtor  in,  and  showed 
him  the  injustice  of  paying  two  small  creditors  in  full 
and  leaving  the  larger  ones  to  take  what  was  left.  Then 
they  persuaded  him  to  prepare  a  voluntary  petition  in 
bankruptcy.  This  petition  would  have  been  put  through, 
had  not  the  creditors  who  had  attached  seen  their  mis- 
take and  consented  to  the  assignment. 

Shrinkage  of  Accounts  Receivable 

And  now  a  word  about  the  book  accounts  which  I 
have  mentioned.  Our  records,  extending  over  a  number 
of  years,  show  that  the  accounts  receivable  of  the  average 
retail  dealer  are  not  worth  60  cents  on  the  dollar.  I  be- 
lieve our  records  for  the  past  year  show  that  we  collected 
only  56  cents  and  a  fraction.  The  ordinary  retail  dealer 
sometimes  carries  old  and  worthless  accounts  as  live 
assets.  I  know  of  a  case  where  a  certain  corporation  had 
been  selling  to  Mexican  laborers  and  Indians  on  credit. 
In  a  recent  attempt  to  collect  these  accounts,  we  found 
that  many  of  the  debtors  had  drifted  away;  quite  a  num- 
ber had  been  dead  for  some  time;  and  one  or  two  were 
in  the  penitentiary;  and  yet  all  those  accounts  were  car- 
ried as  live  assets.  The  president  of  the  corporation  was 
fooling  himself  as  much  as  he  was  his  creditors. 

Many  a  retailer  does  not  know  the  full  name  or  ad- 
dress of  a  large  number  of  his  regular  customers.  He 
relies  on  his  delivery  clerk,  who,  after  the  failure,  is  too 
busy  hunting  for  another  job  to  assist  the  adjuster,  or,  as 
often  happens,  is  immediately  employed  by  a  competitor, 
who  hopes  to  secure  all  this  new  trade,  and  of  course  will 
give  no  assistance  to  the  assignee. 


208  MERCANTILE  CREDITS 

Discounting  the  Debtor's  Statements 

If  the  debtor  is  asking  for  an  extension,  the  creditors 
should  invariably  take  an  inventory  and  thoroughly  inves- 
tigate the  situation  before  granting  or  refusing  the  exten- 
sion. When  a  debtor  asks  for  an  extension  he  will  tell 
you  he  has  a  certain  amount  of  merchandise  and  fixtures, 
and  that  he  has  so  many  thousand  dollars5  worth  of  bills 
receivable  that  are  good — in  fact,  he  has  everything  but 
money — and  he  will  make  almost  any  kind  of  a  promise 
if  only  the  creditors  will  allow  him  to  continue.  I  have 
heard  debtors  who  had  only  a  small  retail  business  make 
promises  that  many  a  wholesale  business  would  hesitate 
to  make. 

But  if,  on  the  other  hand,  the  debtor  wishes  to  settle 
with  his  creditors  for  50  cents  on  the  dollar,  or  any  other 
amount,  everything  assumes  a  darker  hue.  The  merchan- 
dise is  shop  worn,  out  of  style;  the  stock  is  broken;  the 
accounts  are  old  and  uncollectible ;  the  fixtures  are  mort- 
gaged or  on  lease  contract.  In  fact,  it  would  seem  that 
the  creditors  must  have  forgotten  all  about  this  man, 
otherwise  he  never  would  have  been  allowed  to  continue. 

Now,  when  an  inventory  is  taken  it  will  generally 
show  that  the  man  who  has  asked  for  the  extension,  has 
inflated  the  amount,  or  at  least  the  value  and  condition, 
of  all  his  assets;  while  the  other  man  has  depreciated 
them,  knowing  that  a  much  better  settlement  can  be  ob- 
tained if  the  assets  are  small.  If  a  disinterested  party 
makes  an  investigation,  his  report  will  show  the  condi- 
tions in  their  true  light;  and  it  is  on  this  report,  rather 
than  upon  the  debtor's  statement,  that  the  creditors 
should  base  their  action. 

Procedure  when  Extension  is  Granted 

When  the  creditors  think  the  debtor  is  entitled  to  an 


ADJUSTMENT  WITH  DEBTORS  209 

extension,  some  sort  of  an  agreement  should  be  entered 
into  which  will  not  only  bind  the  debtor  to  perform  cer- 
tain duties,  but  will  also  prevent  the  creditors  themselves 
from  taking  advantage  of  each  other  or  of  the  debtor,  so 
long  as  he  makes  the  promised  payments.  We  have 
found  it  more  effective,  and  I  may  say  simpler,  where  an 
extension  is  granted,  to  allow  the  debtor  to  give  his  note 
for  the  amount  of  the  indebtedness.  The  person  to  whom 
the  note  is  made  payable  then  obtains  the  assignment  to 
himself  of  the  claims  of  all  the  creditors.  This  so 
changes  the  situation  that  the  debtor  has  but  one  creditor 
— the  man  to  whom  he  has  given  his  note  for  $5,000  or 
$10,000,  or  whatever  the  amount  may  be;  and  the  credi- 
tors, having  assigned  their  claims  to  the  holder  of  this 
note,  are  no  longer  able  to  molest  the  debtor,  as  they 
have  no  claims  against  him. 

Protecting  the  Creditors 

The  one  creditor  holding  the  note — who  is,  in  fact,  a 
trustee  for  all  the  creditors — should  be  in  a  position  at 
any  time  to  demand  the  payment  of  his  note  if  the  debtor 
becomes  delinquent  in  his  payments,  or  if  anything  hap- 
pens to  the  debtor  which  in  any  way  imperils  the  interests 
of  the  creditors.  The  form  of  jiote  used  in  such  cases 
provides  that  the  note  shall  immediately  become  due  and 
payable  if  any  of  the  instalments  or  interest  thereon  be 
not  paid  when  due;  or  upon  any  attachment  or  other  pro- 
cess of  court,  or  any  other  action  or  proceedings  against 
the  maker  of  the  note ;  or  any  notice  of  intention  to  sell, 
or  of  any  sale  of  the  stock  in  bulk.  These  provisions  are 
very  necessary  to  protect  the  interests  of  the  creditors. 

Protecting  the  Debtor 

At  the  time  this  settlement  is  agreed  on,  it  is  scarcely 


210  MERCANTILE  CREDITS 

possible  that  the  creditors,  or  even  the  debtor  himself, 
will  be  able  to  state  accurately  the  exact  amount  of  his 
indebtedness;  we  find  it  convenient,  therefore,  and  often 
of  considerable  advantage  to  draw  the  note  for  more  than 
the  amount  the  debtor  thinks  he  owes;  but,  for  the  pro- 
tection of  the  debtor,  we  give  him  a  contract  or  agreement 
providing  that  the  holder  of  the  note,  who  is  also  the 
assignee  of  the  claims  of  all  the  creditors,  shall  credit 
upon  this  note  the  difference  between  the  amount  of 
claims  actually  assigned  and  the  face  of  the  note.  This 
is  a  protection  to  the  creditors  themselves,  and  to  their 
assignee,  and  is  fair  to  the  debtor. 

Providing  for  Contingencies 

The  older  credit  men  will  at  once  recognize  the  wis- 
dom of  providing  for  the  various  contingencies  I  have 
mentioned.  If  a  debtor  is  inclined  to  be  tricky,  or  is 
poorly  advised,  or  of  his  own  volition  shall  decide  that 
the  best  thing  to  do  is  to  save  what  he  can  from  the 
wreck,  then,  if  the  ordinary  note  has  been  taken  instead 
of  one  with  these  provisions,  the  debtor  can  make  a  few 
weekly  or  monthly  payments  to  the  holder  of  the  note, 
and  immediately  thereafter  sell  out,  or  file  a  notice  of  in- 
tention to  sell,  and  dispose  of  his  business.  He  might  be 
able  to  sell  for  cash,  with  which  he  could  purchase  real 
estate,  file  a  homestead,  buy  building  and  loan  stock,  or 
in  any  one  of  a  dozen  different  ways  succeed  in  placing 
the  proceeds  of  the  business  beyond  the  reach  of  his 
creditors. 

Investigate  Before  Settlement 

The  foregoing  applies  to  extensions.  If  the  debtor 
asks  for  a  settlement  at  50  cents  on  the  dollar,  or  at  any 
other  percentage  of  his  liabilities,  he  should  be  compelled 


tl 


ADJUSTMENT  WITH  DEBTORS  211 

to  pay  more  than  could  be  realized  through  bankruptcy, 
for  the  advantages  to  him  are  so  great  that  even  though 
he  cannot  raise  the  full  amount  of  his  settlement  in  cash, 
he  should  make  up  the  difference  later.  But  the  debtor's 
proposition  to  settle  should  not  be  hastily  accepted. 
Attempted  deception  is  common  under  such  circumstances. 
Sometimes  fraud  can  be  proved,  but  we  have  seen  too 
many  cases  where  we  felt  morally  certain  that  the  debtor 
had  carefully  planned  for  this  settlement  months  in  ad- 
vance, and  yet,  not  having  the  proof  of  our  convictions, 
nor  any  way  of  obtaining  such  evidence,  have  been  com- 
pelled to  accept  a  settlement  which  we  knew  was  a  rank 
injustice. 

We  have  hundreds  of  cases  coming  into  our  office 
every  year,  and  no  two  are  exactly  alike.  I  have  in  mind 
one  particular  settlement  where  the  debtor  was  believed 
to  have  gradually  withdrawn  funds  from  the  business, 
placing  them  in  the  care  of  a  relative  or  friend  in  Sacra- 
mento, or  some  distant  town.  These  funds  were  with- 
drawn so  gradually  that  the  business  did  not  appear  to 
suffer.  When  the  time  came  he  borrowed  this  amount, 
the  accumulation  of  his  savings,  from  his  friend  in  Sacra- 
mento, giving  him  a  note,  and  then  he  paid  one  certain 
creditor,  preferring  him.  Soon  after,  it  was  found  that 
he  was  insolvent,  and  he  made  a  settlement  with  his  credi- 
tors at  40  cents  on  the  dollar.  He  had  no  difficulty  in 
preparing  the  evidence  to  corroborate  his  statements  as  to 
the  amounts  he  had  borrowed;  but  I  am  convinced  now 
beyond  a  shadow  of  a  doubt  that  the  money  borrowed 
was  his  own  money.  Nevertheless,  so  carefully  had  he 
arranged  matters  that  it  would  have  been  very  difficult,  if 
not  impossible,  to  prove  in  bankruptcy  proceedings  that 
a  fraud  had  been  committed.  Therefore,  on  the  evidence, 
the  creditors'  committee  believed  they  were  justified  in 


212  MERCANTILE  CREDITS 

recommending  this  man's  offer  of  settlement  for  accept- 
ance. Six  months  afterward,  he  came  into  my  office  and 
said  he  was  in  a  position  to  finance  any  small  dealer  who 
needed  ready  cash  to  settle  with  his  creditors;  in  other 
words,  he  was  now  a  financier  I 

Consent  of  Creditors 

One  of  the  most  important  and  most  difficult  tasks 
of  the  assignee  or  the  creditors'  committee  is  to  obtain 
the  consent  of  the  creditors  to  the  plan  of  settlement. 
This  is  done  in  various  ways.  The  creditors  are  notified 
that  a  meeting  has  been  held,  and  they  are  advised  as  to 
whatever  action  has  been  decided  on.  The  amount  of 
assets  and  liabilities  are  stated,  as  well  as  the  causes 
leading  up  to  the  failure  or  whatever  it  may  be.  Original 
agreements  are  circulated  for  the  signatures  of  the  credi- 
tors, with  a  letter  of  explanation,  or,  if  it  is  impracticable 
to  circulate  original  agreements,  then  the  facts  and  figures 
are  given  in  a  letter,  with  the  recommendations  of  the 
committee,  which  asks  for  written  authority  to  sign  the 
name  of  the  creditor  to  the  original  agreement. 

Creditors  Must  Wait  for  Their  Money 

Now,  whether  the  case  be  that  of  an  assignment,  an 
extension,  or  a  composition  settlement,  the  creditors  want 
their  money  as  soon  as  they  can  get  it,  and  some  of  them 
become  very  impatient  because  the  distribution  is  not 
made  forthwith.  This  may  be  done  if  the  assignee,  or 
the  person  through  whom  the  settlement  is  conducted,  is 
absolutely  sure  that  all  creditors  have  consented  to  the 
settlement,  or  have  agreed  to  the  assignment.  But  the 
assignee  cannot  be  positive;  and  it  frequently  happens 
some  two  or  three  months  after  a  settlement  has  been 
made,  or  an  extension  granted,  or  the  assets  have  been 


ADJUSTMENT  WITH  DEBTORS  213 

sold  under  an  assignment,  that  some  unheard-of  creditor 
appears.  He  may  be  a  local  creditor  who  has  neglected 
his  collections,  or  he  may  be  an  Eastern  creditor  who, 
depending  upon  his  salesman's  reports,  has  not  yet  re- 
ceived a  report  on  this  particular  customer.  Thus,  for 
the  protection  of  the  debtor,  as  well  as  for  his  own  pro- 
tection and  that  of  the  committee,  the  assignee  should 
hold  the  entire  proceeds  of  the  assignment  at  least  four 
months  after  the  date  of  the  transfer,  because  this  trans- 
fer might  become  invalid  and  be  set  aside  if  within  that 
time  the  debtor  should  file  a  voluntary  petition  in  bank- 
ruptcy, or  if  certain  creditors,  having  a  personal  spite  or 
grudge  against  the  debtor,  should  insist  on  payment  in 
full.  This  often  happens  when  the  debtor  fails  just  after 
receiving  his  first  shipment  from  one  or  more  firms,  or 
when  distant  creditors — and  sometimes  local  ones  as  well 
— instead  of  investigating  the  situation  carefully  for  them- 
selves, file  their  claims  with  their  own  attorney.  He,  un- 
fortunately, often  sees  but  one  thing,  namely,  the  fees 
which  he,  the  attorney,  is  to  make  out  of  this  particular 
collection.  Now,  this  attorney  may  believe  that  he  can 
play  the  "dog  in  the  manger"  act,  and  will  hold  up  a 
settlement  unless  he  receives  payment  in  full  for  his  client. 
Sometimes  he  carries  this  too  far,  and  the  other  creditors 
deliberately  file  an  involuntary  petition  in  bankruptcy  to 
compel  this  "dog  in  the  manger"  to  prorate  with  the 
others,  even  though  they  know  it  is  costing  them  many 
dollars. 

Again,  if  the  assignee  distributes  the  money  at  once, 
and  an  unfriendly  trustee  in  bankruptcy  is  elected,  he  may 
demand  an  accounting  from  the  assignee,  who  has  re- 
tained nothing;  and  this  will  be  very  embarrassing,  for 
you  can  well  imagine  the  difficulty  of  collecting  the  money 
paid  to  far-distant  creditors.  This  is  why  all  funds  in 


214  MERCANTILE  CREDITS 

assignment  cases  are  held  for  four  months,  to  protect  the 
assignee  as  well  as  the  debtor. 

Distribution  of  Dividends 

In  cases  of  assignment  the  first  dividend  should  be 
distributed  immediately  after  the  four  months  have  ex- 
pired, and  other  dividends  should  follow  as  rapidly  as 
funds  accumulate  sufficient  to  make  a  dividend  worth 
while.  In  cases  of  extension,  dividends  should  be  dis- 
tributed as  often  as  payments  are  made  by  debtor,  unless 
such  payments  are  so  small  as  to  make  the  dividend  in- 
significant; but  a  dividend  should  always  be  declared,  if 
all  creditors  have  agreed  to  the  settlement,  as  soon  as 
there  is  sufficient  for  a  10  per  cent  payment. 

Difficulty  with  Foreign  Creditors 

In  composition  settlements,  the  local  creditors,  who 
are  familiar  with  the  situation,  generally  sign  the  agree- 
ment without  much  delay,  but  foreign  creditors — those 
who  are  some  distance  away  from  the  scene  of  action — 
view  the  situation  so  differently  that  they  always  cause 
more  or  less  trouble.  About  two-thirds  of  the  foreign 
creditors  will  consent  to  the  settlement  if  it  is  recom- 
mended by  the  local  creditors.  The  other  third  will  fail 
to  answer  letters,  or  will  state  that  their  claims  have  been 
forwarded  to  attorneys,  or  that  they  want  a  greater  per- 
centage paid  on  their  claims,  or  that  they  want  a  prefer- 
ence. Their  wants  are  so  many,  and  their  indifference  to 
your  letters  so  great,  that  an  immediate  settlement  or  an 
immediate  distribution  is  often  impossible;  and  then 
comes  trouble  from  those  who  have  already  consented. 
They  argue  that,  having  consented  to  the  settlement,  they 
should  receive  their  pro  rata  at  once — overlooking  the 
fact  that  a  settlement  is  rarely  possible  unless  all  creditors 
give  their  consent  to  the  same  action. 


ADJUSTMENT  WITH  DEBTORS  '215 

Recently  we  had  in  process  of  settlement  an  estate 
where  the  principal  creditors — the  three  creditors  who 
formed  the  creditors'  committee,  having  among  them- 
selves about  $12,000  of  liabilities — had  accepted  and 
strongly  recommended  a  settlement  at  50  cents  on  the 
dollar;  but  this  settlement  could  only  be  brought  about 
by  taking  secured  notes  payable  at  $400  a  month,  the 
security  being  a  ranch,  a  residence  property,  and  apart- 
ment houses.  All  the  creditors  but  one  consented.  This 
man  was  in  Chicago,  and  letters  and  telegrams  were  sent 
to  him  repeatedly  without  effect.  Finally,  in  response  to 
a  more  urgent  telegram  than  usual,  he  wired  back  that 
he  would  take  50  cents  on  the  dollar  provided  Chicago 
exchange  were  placed  in  his  hands  before  the  i9th  instant. 
This  gave  us  five  days  to  collect ! 

Attachments  Sometimes  Necessary 

I  have  undertaken  to  tell  you  the  advantages  of  a 
friendly  settlement  over  attachment  or  bankruptcy,  but 
very  often  attachments  are  necessary  to  bring  about  a 
friendly  settlement.  Sometimes  the  sheriff  is  placed  in 
charge  of  a  man's  business  to  protect  him  from  some  in- 
dividual creditor,  or  to  protect  some  creditor  as  against 
other  creditors — for  we  find  that  creditors  fear  each 
other  fully  as  much  as  they  do  the  debtor.  Attachments 
are  necessary  at  times  when  some  creditor  has  become 
impatient,  and  has  demanded  and  received  a  chattel  mort- 
gage as  security  on  some  past-due  indebtedness,  thus 
obtaining  a  preference;  or  when  a  debtor  has  disap- 
peared; or  when,  after  a  place  has  been  destroyed  by  fire, 
the  debtor  for  some  reason  declines  to  turn  his  insurance 
over  to  the  creditors.  But  such  attachments  should  be 
for  the  benefit  of  all  creditors. 

Sometimes  a  debtor  is  recklessly  extravagant,   and 


2i6  MERCANTILE  CREDITS 

appears  to  be  dissipating  his  own  assets.  Sometimes  he 
has  transferred  a  portion  of  his  assets,  or  is  suspected  of 
having  committed  some  act  that  would  be  a  fraud  upon 
his  creditors.  Then  an  attachment  must  be  made  to 
create  an  act  of  bankruptcy,  for  in  such  cases  bankruptcy 
is  necessary  unless  the  debtor,  after  having  been  attached, 
willingly  consents  to  a  peaceable  settlement  without  fur- 
ther litigation.  Bankruptcy  is  necessary  also  when  the 
debtor  has  conveyed  his  assets  with  intent  to  hinder,  de- 
lay, or  defraud  any  creditor,  or,  as  just  stated,  when  he 
has  given  a  chattel  mortgage  for  the  purpose  of  preferring 
some  one  creditor  over  the  others;  or  when  some  creditor 
having  been  poorly  advised  by  his  attorney,  has  attached 
the  greater  portion  of  the  debtor's  assets,  believing  that 
his  attachment  will  hold  good  in  spite  of  bankruptcy,  and 
that  he  will  receive  his  pay  in  full. 

Debtor  Should  be  Released 

In  nearly  all  cases  of  assignment,  the  debtor  believes 
that  he  is  being  fully  released  from  all  his  obligations ;  and 
where  the  failure  is  an  honest  failure,  and  there  is  no  im- 
mediate prospect  of  the  debtor's  recovering  his  financial 
stability,  this  release  should  be  given  to  him  by  his 
creditors. 

I  have  known  of  very  few  cases  where,  an  assignment 
having  been  made  and  no  release  given  to  the  debtor,  the 
latter  voluntarily  came  in  afterwards  to  pay  off  the  bal- 
ance of  the  indebtedness.  The  only  case  I  now  recall  is 
that  of  two  brothers,  Italians,  who  had  been  unsuccess- 
fully conducting  a  cigar  stand.  They  made  an  assignment 
for  the  benefit  of  creditors,  without  asking  for  a  release. 
There  was  a  deficiency,  as  there  generally  is  in  such  cases ; 
and  one  day,  about  six  months  later,  the  younger  brother 
came  into  the  office  and  wanted  to  know  how  the  settle- 


ADJUSTMENT  WITH  DEBTORS  217 

ment  came  out.  When  advised  of  the  amount  that  was 
still  owing,  he  produced  the  cash  and  paid  off  the  entire 
balance.  And  how  do  you  suppose  he  obtained  this  cash? 
He  was  working  in  a  ditch,  digging  sewers  at  $1.75  a  day. 
This  is  the  one  exception  to  the  general  rule,  in  my  per- 
sonal experience. 

Comparative  Costs  of  Settlement  and  Bankruptcy 

The  advantages  of  the  friendly  settlement  as  to  the 
matter  of  cost  may  best  be  realized  by  comparison.  For 
example,  take  a  case  in  bankruptcy  where  the  total  assets 
of  the  estate  will  amount  to  about  $20,000,  more  or  less, 
and,  after  the  most  careful  administration  by  a  competent 
trustee,  he  has  for  distribution,  we  will  say,  $10,000  in 
actual  cash.  We  will  assume  that  there  are  one  hundred 
creditors.  The  expenses  of  administering  this  estate  by 
the  trustee,  or  through  the  bankruptcy  court,  would  range 
from  $700 — which  is  the  lowest  possible  amount  that  we 
can  imagine — up  to  $1,600  or  even  $2,000,  while  an 
assignee  would  not,  or  should  not,  receive  more  than 
$750,  and  the  probabilities  are  that  his  fees  would  be 
much  less  than  that  amount,  the  maximum  being  $920 
and  the  minimum  $320.  The  difference  is  perceptible,  to 
say  the  least. 

As  regards  bankruptcy,  the  annual  report  of  the  San 
Francisco  Board  of  Trade  shows  that  in  the  year  1912 
the  distribution  under  bankruptcy  to  the  creditors  in  all 
cases  handled  by  them  was  21  9/10  per  cent  as  against 
55  3/1  o  per  cent  in  case  of  assignment.  The  reports  of 
the  Los  Angeles  Wholesalers  Board  of  Trade  for  1911 
show  37  4/10  per  cent  dividends  under  bankruptcy  as 
against  57  8/10  per  cent  under  assignments,  and  in  the 
year  1912  the  ratio  is  about  the  same.  And  further,  the 
Attorney  General's  report  for  1912  shows  the  average 


2i8  MERCANTILE  CREDITS 

expense  of  administration  to  be  29  7/10  per  cent  of  the 
assets  realized,  while  in  California  alone  the  expense  was 
33  per  cent. 

Saving  of  Time 

Now,  as  to  the  saving  of  time  that  can  be  made 
through  this  friendly  settlement.  I  would  like  to  cite  a 
special  case  that  came  to  my  notice  not  long  ago  where  a 
friendly  settlement  was  made  with  a  certain  debtor  about 
forty  or  fifty  miles  away,  who  proposed  to  pay  his  credi- 
tors as  fast  as  the  cash  came  over  the  counter,  or  as  his 
collections  were  made.  He  even  offered,  if  the  creditors 
preferred,  to  turn  over  all  his  daily  receipts  to  a  friend, 
and  let  the  friend  remit  to  the  creditors.  But  the  reputa- 
tion of  this  particular  debtor  was  not  of  the  best,  and  the 
creditors  therefore  hesitated  about  trusting  his  friend, 
for,  although  the  latter  was  responsible  and  of  unques- 
tionable integrity,  he  was  nevertheless  a  friend  of  the 
debtor,  which  was  enough  to  condemn  him.  The  credi- 
tors therefore  told  the  friend,  who  acted  as  mediator  in 
this  settlement,  that  they  would  sell  their  claims  at  a  dis- 
count of  10  per  cent.  This  proposition  was  accepted,  and 
the  creditors  received  their  money  in  weekly  instalments. 
While  they  did  not  receive  100  cents  on  the  dollar,  it  is 
very  doubtful  whether  they  would  have  received  any 
greater  amount  through  debtor's  own  manipulation  of  his 
funds,  and  certainly  not  as  much  in  bankruptcy.  With- 
out the  medium  of  some  adjustment  bureau,  and  in  the 
absence  of  some  one  who  could  devote  the  necessary  time 
to  handling  a  matter  of  this  kind,  some  creditor  would 
probably  have  attached  this  debtor,  and  this  would  have 
resulted  in  bankruptcy,  or  else  that  one  creditor  would 
have  secured  a  full  settlement  of  his  claim,  while  the 
others  would  have  been  left  out  in  the  cold. 


ADJUSTMENT  WITH  DEBTORS  219 

Extensions  Generally  Successful 

As  to  the  results  that  are  obtained  through  settlement 
outside  the  courts,  it  may  be  safe  to  say  that  nearly  all 
composition  settlements  will  produce  greater  dividends 
than  bankruptcy,  the  exceptions  being  where  the  debtor 
is  dishonest.  In  case  of  extension  the  creditors  will  in 
most  cases  receive  100  cents  on  the  dollar.  My  observa- 
tion has  been  that  about  two-thirds  of  the  extensions  are 
successful;  and  in  such  cases  the  creditors  receive  their 
pay  in  full  and  the  debtor  is  able  to  continue ;  but  in  about 
one-third  of  these  cases  the  debtor  is  so  crippled  by  the 
payments  that  he  makes  or  attempts  to  make,  that  before 
he  has  completed  them  he  is  compelled  to  liquidate  either 
through  an  assignment  or  through  bankruptcy.  But  even 
though  he  cannot  carry  his  payments  to  completion,  the 
creditors  in  most  cases  have  received  a  greater  amount 
than  they  could  have  recovered  had  they  attached,  or  had 
the  debtor  filed  a  voluntary  petition  in  the  beginning. 

Advantages  of  Settlement  for  the  Debtor 

I  have  been  trying  to  show  you  some  of  the  advan- 
tages of  the  friendly  settlement,  but  only  from  the  stand- 
point of  the  creditor.  The  debtor,  however,  is  protected 
and  benefited  by  this  mode  of  settlement  fully  as  much 
as  the  creditor.  If  there  were  no  adjustment  bureaus  or 
friendly  adjustments,  nearly  every  unsuccessful  merchant 
would  be  attached  or  thrown  into  bankruptcy,  as  I  under- 
stand is  still  the  case  in  the  East;  and  by  some  of  his 
creditors,  at  least,  he  would  be  branded  as  a  crook,  sim- 
ply because  they  had  lost  money  in  their  dealings  with 
him. 

We  find  that  this  point  of  view  is  very  often  taken. 
At  a  meeting  of  creditors,  some  disgruntled  individual, 
who  has  perhaps  neglected  to  exercise  the  ordinary  pre- 


MERCANTILE  CREDITS 

cautions,  will  say,  "Well,  the  man's  a  crook;  let's  get  after 
him  and  prosecute  him  for  fraud."  But  it  does  not  neces- 
sarily follow,  because  a  man  owes  you  a  debt  and  is  pre- 
vented by  incompetency  or  by  some  of  your  competitors 
from  paying  you  the  full  amount  of  your  claim,  that  he  is 
dishonest.  His  intentions  may  be  as  honorable  as  yours. 
His  business  may  not  be  as  prosperous  as  some,  but  it  is 
furnishing  him  with  a  livelihood;  he  buys  many  of  your 
goods  and  pays  for  them  after  a  fashion.  He  may  be 
slow  at  times,  it  is  true,  but  there  is  no  prospect  of  loss 
until  something  out  of  the  usual  happens,  and,  even  when 
this  something  happens,  the  debtor  may  obtain  an  exten- 
sion; he  may  pay  out  in  full;  and  he  may  continue  to  buy 
many  thousands  of  dollars'  worth  of  supplies  from  you; 
moreover,  having  learned  his  lesson,  he  may  discount  his 
bills. 

There  are  many  such  cases;  for  the  debtor,  during  his 
period  of  extension,  is  generally  compelled  to  buy  for 
cash,  and,  if  he  wins  out,  he  has  learned  that  the  item  of 
discount  amounts  to  a  considerable  sum  of  money;  and 
then,  too,  he  has  acquired  the  habit  of  discounting.  If  a 
man  is  insolvent  and  makes  an  equitable  settlement  with 
his  creditors,  he  generally  makes  good;  and  the  creditors 
who  lost  25  or  30  per  cent,  or  even  a  greater  amount,  in 
their  former  settlement  with  him,  now  consider  him  a 
safer  credit  risk  than  before,  for  by  this  settlement  with 
his  creditors  he  has  wiped  out  a  considerable  portion  of 
his  debts  without  diminishing  his  assets.  They  now  know 
his  exact  condition,  whereas  before  they  merely  thought 
they  did.  The  man  has  paid  his  debt  in  full  so  far  as  he 
is  able ;  in  fact,  he  has  paid  his  creditors  generally  a  great 
deal  more  than  they  would  have  received  in  bankruptcy; 
and  he  has  avoided  the  stigma  generally  considered  to  be 
attached  to  the  bankrupt. 


ADJUSTMENT  WITH  DEBTORS  221 

Adjustment  Means  Cooperation 

Californians  will  all  remember  the  failure  of  the 
melon  growers  industry  in  the  early  days,  and  how  by  co- 
operation they  were  able,  through  the  Melon  Growers 
Association,  to  raise  melons  and  ship  them  with  profit 
instead  of  having  only  red  ink  returns.  You  may  have 
heard  also  of  the  Orange  and  Lemon  Growers  Associa- 
tions. Now,  what  these  various  associations  are  to  those 
particular  industries,  the  Adjustment  Bureau  is  to  the 
credit  man.  The  Adjustment  Bureau  is  simply  coopera- 
tion among  creditors  or  credit  men.  The  Los  Angeles 
Wholesalers  Board  of  Trade  is  only  the  machinery  by 
which  the  wishes  of  creditors  are  carried  out.  Coopera- 
tion among  creditors  is  our  work,  and  should  be  the  work 
of  every  merchant.  If  you  remember  this,  you  will  more 
nearly  realize  what  the  National  Association  of  Credit 
Men  is  trying  to  accomplish  by  having  adjustment  bureaus 
connected  with  its  local  branches  in  all  the  large  cities. 

Cooperation  Pays 

Generally  speaking,  bankruptcy  cases  cost  about  10 
to  20  per  cent  of  your  claims.  If  you  have  a  claim 
against  a  bankrupt  of  some  thousands  of  dollars,  and  you 
receive,  we  will  say,  30  cents  on  the  dollar,  in  bankruptcy, 
it  is  safe  to  conclude  that  in  the  majority  of  cases  you 
would  have  received  40  to  45  per  cent  had  the  claims  been 
administered  by  some  assignee,  some  creditor  appointed 
for  the  parties,  a  creditors'  committee,  or  an  adjustment 
bureau. 

We  had  a  case  some  years  ago  where  in  bankruptcy 
we  could  not  hope  to  realize  more  than  60  cents  on  the 
dollar,  and  this  particular  debtor  was  extremely  anxious 
to  go  into  bankruptcy.  Some  of  his  larger  creditors 
labored  with  him  for  three  days  or  more,  trying  to  get  him 


222  MERCANTILE  CREDITS 

to  accept  an  extension  rather  than  go  into  bankruptcy. 
At  last  they  succeeded,  and,  putting  an  efficiency  manager 
in  charge,  with  the  debtor  working  under  his  direction  on 
a  salary,  they  continued  doing  business;  and  paid  100 
cents  on  the  dollar.  When  the  debtor  had  completed  his 
payments,  he  made  a  statement  to  the  mercantile  agencies 
which  showed  that  he  had  some  $6,000  greater  surplus 
than  the  surplus  he  showed  on  paper  when  he  made  the 
assignment.  This  is  one  instance.  There  are  others  that 
have  worked  out  differently,  but  many  cases  can  be  made 
to  pay  out  the  same  way. 


CHAPTER  XII 

BANKRUPTCY 

BY  W.  T.  CRAIG 

History  of  the  Bankruptcy  Law 

Among  modern  nations,  the  English  have  the  most 
perfect  system  of  bankruptcy  law,  and  our  system  is 
borrowed  largely  from  theirs.  The  English  system  dates 
from  the  time  of  Henry  VIII.  In  those  days  the  mer- 
chant sent  out  his  ships,  simply  praying  that  they  might 
reach  their  destination  and  return  safely.  If  either  or 
both  of  these  things  failed  to  happen,  he  was  very  likely 
unable  to  meet  his  obligations  to  his  creditors  and  be- 
came a  bankrupt.  His  creditors,  however,  did  not  have 
much  consideration  for  him  on  account  of  his  misfortunes. 
The  laws  did  not  provide  that  he  should  have  the  right  to 
petition  himself  into  bankruptcy  and  be  relieved  of  his 
debts;  they  simply  provided  that,  under  those  circum- 
stances, his  creditors  might  throw  him  into  bankruptcy 
and  divide  what  he  had.  He  had  to  pay  the  balance  as 
best  he  could,  and,  if  he  did  not  pay  it,  he  went  to  jail. 

That  conception  of  bankruptcy  continued  down  to  a 
comparatively  recent  time.  Only  during  the  last  century 
has  the  modern  idea  arisen  that  the  bankruptcy  law  is  as 
much  for  the  benefit  of  the  debtor  as  the  creditor.  Its 
purpose  is  not  only  to  distribute  the  bankrupt's  assets 
pro  rata  among  the  creditors,  but  to  take  from  a  man  the 
load  of  debt  which  makes  him  a  drone,  and  allow  him 
again  to  enter  society,  and  possibly  retrieve  his  fortunes. 

223 


224  MERCANTILE  CREDITS 

Moral  Obligations  of  Bankrupts 

The  idea  that  bankruptcy  relieves  a  man  of  his  debts 
is,  unfortunately,  an  idea  commonly  entertained  even  by 
bankrupts  themselves.  It  does  not;  but,  like  the  statute 
of  limitations,  it  relieves  him  of  the  possibility  of  a  credi- 
tor's collecting  the  debt,  although  we  do  not  regard  a  man 
who  will  not  pay  a  debt  because  it  is  outlawed,  as  a  man 
of  high  moral  character.  The  moral  obligation  to  pay 
debts  exists  just  the  same  after  a  man  has  been  discharged 
in  bankruptcy  as  before ;  and  I  am  glad  to  say  that  many 
a  man  does  pay  his  debts,  even  after  he  has  been  so  dis- 
charged. Such  a  man  is  thereafter  established  in  the 
community  as  entitled  to  credit  above  men  of  equal  finan- 
cial standing;  for  the  question  of  integrity  is  perhaps 
more  worthy  of  consideration  by  a  credit  man  than  the 
question  of  financial  standing.  The  increasing  weight 
given  to  integrity  in  credit  considerations  is  significant. 

Bankruptcy  Law  Definitely  Established 

There  is  always  a  certain  agitation  for  the  repeal  of 
the  national  bankruptcy  act;  and  not  long  ago  there  was  a 
debate  between  two  universities  in  which  the  question  of 
the  evening  was:  "Resolved,  that  the  bankruptcy  law 
should  be  repealed."  But  I  do  not  believe  it  is  a  very 
vital  question  any  more.  I  will  not  assert  that  whatever 
is,  is  right;  but  it  is  safe  to  say  that  when  a  great  majority 
of  men  definitely  agree  upon  one  thing,  the  dissenters  are 
wrong;  and  practically  every  civilized  nation  in  the  world, 
except  China,  has  a  bankruptcy  statute.  In  1900  Japan 
passed  a  bankruptcy  law  which  provides  that  a  man  must 
pay  his  debts,  and,  if  he  does  not,  his  creditors  may  take 
all  that  the  family  has;  and,  if  that  is  not  enough,  then  the 
law  provides  that  he  shall  not  be  allowed  to  vote  any 
more. 


BANKRUPTCY  225 

Voluntary  and  Involuntary  Bankruptcy 

Bankruptcy  is  of  two  kinds,  voluntary  and  involun- 
tary. Voluntary  bankruptcy  is  open  to  any  one.  A 
debtor,  whether  he  owes  one  dollar  or  a  million  dollars, 
may  file  a  petition  in  the  United  States  District  Court  to 
be  declared  a  bankrupt;  and  he  will  be  accommodated. 
All  classes  of  corporations  except  four  may  go  into  volun- 
tary bankruptcy.  The  four  are  banking,  insurance,  rail- 
way, and  municipal  corporations;  they  may  neither  go 
into  bankruptcy  voluntarily,  nor  be  forced  into  it.  All 
other  corporations  may  come  under  the  bankrupt  law  by 
either  method. 

The  four  classes  of  corporations  that  I  have  named 
may  not  be  thrown  into  bankruptcy  for  good  reasons. 
The  banking  corporations  are  usually  governed  by  bank- 
ing laws  which  do  not  permit  bankruptcy.  The  state 
law  governs  the  state  bank,  and  the  national  law  governs 
the  national  bank.  It  would,  of  course,  be  obviously 
improper  to  throw  a  municipal  corporation  into  bank- 
ruptcy; and  the  railways  are  of  such  interstate  importance 
that  it  would  not  be  expedient  to  allow  them  to  be 
thrown  into  bankruptcy.  The  same  reasoning  applies  to 
insurance  corporations. 

Before  you  can  throw  a  person  into  involuntary  bank- 
ruptcy many  conditions  must  be  met,  and  a  credit  man  in 
giving  credit  either  to  a  corporation  or  to  an  individual, 
must  take  into  account  the  fact  that  if  the  debt  is  not 
paid,  he  may  have  considerable  difficulty  in  getting  that 
corporation  or  person  into  bankruptcy  so  that  he  may 
get  his  share  of  the  assets.  For  instance,  no  wage  earner, 
and  no  person  engaged  chiefly  in  the  tillage  of  the  soil, 
can  be  thrown  into  bankruptcy  at  all.  A  wage  earner  is 
defined  as  a  person  who  works  for  wages,  salary,  or  hire 
for  a  compensation  of  not  more  than  $1,500  a  year.  A 


226  MERCANTILE  CREDITS 

man,  therefore,  who  earns  a  salary  of  $150  a  month, 
would  not  be  considered  a  wage  earner.  A  person  en- 
gaged chiefly  in  the  tillage  of  the  soil  is,  of  course,  a 
farmer. 

Preliminaries  to  Bankruptcy  Proceedings 

Before  any  one  can  be  thrown  into  bankruptcy,  it  must 
be  alleged  and  proved  that  he  has  debts  to  the  amount  of 
at  least  $1,000,  so  that  a  person  who  owes  less  than 
$  1,000  cannot  be  forced  into  bankruptcy,  though  he  may 
be  a  voluntary  bankrupt.  And  before  a  person  may  be 
thrown  into  bankruptcy,  he  must  be  insolvent. 

Now,  the  definition  of  insolvency,  under  the  bank- 
ruptcy statute,  is  peculiar,  and  has  great  significance  to 
credit  men.  A  person  is  insolvent  within  the  meaning  of 
the  bankruptcy  law  when  the  aggregate  of  his  property, 
exclusive  of  any  property  that  he  has  conveyed,  trans- 
ferred, concealed,  or  removed,  or  permitted  to  be  con- 
cealed or  removed,  with  intent  to  hinder,  delay,  or  de- 
fraud his  creditors,  is  not,  at  a  fair  valuation,  sufficient 
in  amount  to  pay  his  debts. 

This  is  an  innocent  looking  definition,  but  it  frequently 
deters  the  credit  man  from  getting  his  debtor  into  bank- 
ruptcy. A  person  whose  entire  property,  at  a  fair  valua- 
tion, exceeds  his  debts,  cannot  be  thrown  into  bankruptcy. 
In  the  state  of  California,  a  man  may  have  a  homestead 
worth  $5,000,  which  is  exempt;  he  may  have  household 
furniture,  which  is  also  exempt,  and  there  are  many  other 
exemptions.  He  is  entitled  to  have  all  of  this  exempt 
property  valued  as  a  part  of  his  assets  if  he  defends  a 
petition  in  bankruptcy.  He  may  owe  $2,000  or  $3,000, 
and  it  may  equal  his  entire  merchandise  or  business  assets ; 
but  you  cannot  throw  nim  into  bankruptcy,  because  this 
indebtedness  is  offset  by  the  value  of  his  home,  his  furni- 


BANKRUPTCY  227 

ture,  and  other  exempt  property.    This  is  something  that 
credit  men  must  always  consider  before  granting  credit. 

Furthermore,  the  debtor  must  be  a  resident  of  the 
judicial  district  in  which  the  bankruptcy  petition  is  filed, 
for  the  greater  part  of  six  months,  which  means  more 
than  three  months. 

"Acts  of  Bankruptcy" 

Let  us  suppose  that  all  these  conditions  exist.  It  is 
then  further  necessary  that  the  debtor  have  committed 
what  is  called  in  the  statute  as  "an  act  of  bankruptcy." 
He  must  have  done  certain  things,  in  addition  to  being 
actually  insolvent.  I  know  men  who  are  absolutely  bank- 
rupt; they  owe  debts  of  large  amounts;  and  yet  they  can- 
not be  thrown  into  bankruptcy,  because  they  have  not 
done  one  of  those  things  called  "an  act  of  bankruptcy"  by 
the  statute.  Those  acts  of  bankruptcy  are  five  in  number 
and  are  as  follows  : 

First.  Having  conveyed,  transferred,  concealed,  or 
removed,  or  permitted  to  be  concealed  or  removed,  any 
part  of  his  property  with  intent  to  hinder,  delay,  or  de- 
fraud his  creditors  or  any  of  them. 

Second.  Having  transferred,  while  insolvent,  any 
portion  of  his  property  to  one  or  more  of  his  creditors 
with  intent  to  prefer  such  creditors  over  his  other 
creditors. 

Third.  Having  suffered  or  permitted,  while  insol- 
vent, any  creditor  to  obtain  a  preference  through  legal 
proceedings,  and  not  having,  at  least  five  days  before  a 
sale  or  final  disposition  of  any  property  affected  by  such 
preference,  vacated  or  discharged  such  preference. 

Fourth.  Having  made  a  general  assignment  for  the 
benefit  of  his  creditors,  or,  being  insolvent,  having  ap- 
plied for  a  receiver  or  trustee  for  his  property,  or  where, 


228  MERCANTILE  CREDITS 

because  of  insolvency,  a  receiver  or  trustee  has  been  put 
in  charge  of  his  property  under  the  laws  of  a  state,  of  a 
territory,  or  of  the  United  States. 

Fifth.  Has  admitted  in  writing  his  inability  to  pay 
his  debts  and  his  willingness  to  be  adjudged  a  bankrupt 
on  that  ground. 

In  short,  a  bankrupt  must  have  transferred  some  of 
his  property  to  a  favored  creditor,  or  concealed  it,  or 
have  been  sued  and  a  judgment  obtained  against  him,  and 
his  property  be  about  to  be  sold  under  execution;  or  he 
must  have  made  an  assignment  for  the  benefit  of  his  credi- 
tors, or  admitted  in  writing  his  inability  to  pay  his  debts, 
and  given  his  written  consent  to  be  adjudged  a  bankrupt 
on  that  ground.  If  he  has  not  done  one  of  these  things, 
no  one  can  throw  him  into  bankruptcy. 

To  meet  this  condition,  it  is  frequently  necessary  to 
create  an  act  of  bankruptcy.  For  this  purpose  certain 
creditors  will  sometimes  bring  suit,  obtain  a  judgment,  and 
levy  an  execution,  and  then  other  creditors  use  the  condi- 
tion so  created  as  ground  for  throwing  the  debtor  into 
bankruptcy.  You  can  see  that,  if  the  bankrupt  is  attempt- 
ing to  pay  favored  creditors,  or  endeavoring  to  keep  out 
of  bankruptcy  in  order  that  certain  of  his  acts  may  not 
be  inquired  into,  he  is  going  to  be  very  careful  that  one 
of  those  "acts  of  bankruptcy"  cannot  be  successfully 
alleged  against  him. 

The  Bankruptcy  Law 

The  national  bankruptcy  law,  I  believe,  is  going  to  be 
a  part  of  the  commercial  organization  of  the  nation.  The 
present  statute  will  probably  be  amended  to  suit  changing 
conditions,  as  has  been  repeatedly  the  case  in  England, 
and  the  statute  is  likely  to  be  more  and  more  considered 
in  commercial  transactions,  because  the  giving  of  credit  is 


BANKRUPTCY  229 

going  to  be  placed  upon  a  more  scientific  basis.  The  Na- 
tional Association  of  Credit  Men  is  seeking  to  accomplish 
this  object.  It  is  opposed  to  the  repeal  of  the  statute, 
which  it  considers  a  necessary  adjunct  to  the  perfecting  of 
the  science  of  credit. 

Delays  in  Bankruptcy  Proceedings 

The  prejudice  against  the  bankruptcy  law — that  is, 
the  earlier  laws — was  caused  by  the  enormous  expense 
and  delay  attendant  upon  the  execution  of  the  law,  and  it 
must  be  admitted  that  under  the  law  of  1867,  which  was 
repealed  in  1878,  the  expenses  and  delays  were  certainly 
inexcusable.  But  no  such  conditions  exist  under  the 
present  statute ;  and,  if  there  is  any  reason  to  believe  that 
in  any  given  case  things  are  mismanaged,  it  is  the  fault  of 
the  credit  men,  because  the  credit  men  now  rule. 

Expense  of  Bankruptcy  Proceedings 

Nor  is  the  expense  of  bankruptcy  great.  The  fees 
provided  by  the  statute  are  very  small.  Take,  for  in- 
stance, the  trustee — the  man  who  is  elected  by  the  credi- 
tors to  take  over  the  assets  of  the  bankrupt  and  to  con- 
vert them  into  money  and  distribute  them.  Upon  him 
rests  the  administration  of  the  entire  estate;  and,  no  mat- 
ter what  he  may  have  done,  or  what  time  he  may  have 
given  to  its  administration,  his  fees  are  fixed  by  the  law  it- 
self; and  you  will  admit  that  they  are  very  small  indeed: 
6  per  cent  on  the  first  $500;  4  per  cent  from  that  to 
$1,500;  2  per  cent  from  $1,500  to  $10,000,  and  I  per 
cent  on  all  above  $10,000.  Where  the  business  of  a 
bankrupt  is  conducted  by  the  trustee,  these  fees  may  be 
doubled.  Now,  because  this  compensation  is  so  small, 
there  is  very  little  opposition  to  the  election  of  a  trustee  in 
the  bankruptcy  courts.  It  is  only  in  very  large  cases  that 


230  MERCANTILE  CREDITS 

any  one  wants  the  office  at  all.  The  contest  for  the  elec- 
tion of  trustee,  if  there  is  any  contest  in  an  ordinary  case, 
does  not  originate  in  the  fact  that  some  one  wants  to  be 
trustee  to  get  the  fees,  but  in  the  fact  that  there  are 
various  classes  of  creditors  who  desire  to  control  the 
estate. 

There  may  be  a  receiver  in  the  case ;  and  the  law  pro- 
vides that  the  receiver's  fees  must  not  exceed  those 
allowed  to  the  trustee.  In  addition  to  that,  the  referee  is 
paid  i  per  cent  on  whatever  dividends  are  paid,  and 
twenty-five  cents  for  each  claim  filed;  and  there  is  a  filing 
fee  of  $30,  $15  of  which  goes  to  the  referee  in  bank- 
ruptcy, $10  to  the  clerk,  and  $5  to  the  trustee.  There  is, 
in  addition,  an  attorney's  fee  allowed  to  the  petitioning 
creditors,  to  the  receiver,  to  the  trustee,  and  to  the  bank- 
rupt. These  fees,  however,  are  so  small  that  the  ordi- 
nary bankruptcy  estate  is  not  attractive  to  the  attorney. 

Advantages  of  Voluntary  Assignment 

It  is  true,  as  explained  in  a  previous  discussion,  that 
the  expense  attendant  upon  a  voluntary  assignment  for 
the  benefit  of  creditors  is  less  than  the  expense  of  a  bank- 
ruptcy proceeding.  There  are  many  reasons  for  this.  It 
is  not  that  the  fees  are  less,  but  the  creditors  under  a 
voluntary  assignment  may  do  many  things  that  cannot  be 
done  under  bankruptcy.  For  instance,  they  may  take  their 
own  time  about  winding  up  the  estate ;  they  may  conduct 
the  business  as  they  see  fit;  they  may  wait  and  dispose  of 
the  goods  in  a  favorable  market. 

Another  reason  is  that  bankrupt  sales  are  notoriously 
sales  at  a  discount,  and  therefore  it  may  be  expected  that 
assets  that  are  sold  in  bankruptcy  will  produce  less  than 
those  sold  under  an  assignment.  As  a  matter  of  fact,  a 
man  who  makes  an  assignment  for  the  benefit  of  credi- 


BANKRUPTCY  231 

tors  will  usually  omit  his  family  claims  and  will  try  to  do 
what  he  can  to  save  himself  from  the  stain  of  bankruptcy; 
whereas,  if  he  goes  into  bankruptcy,  every  claim  that 
exists  against  him  is  inevitably  filed  in  the  bankruptcy 
court 

But  there  are  some  cases  where  the  credit  man  should 
insist  on  bankruptcy.  If  the  man  is  dishonest,  the  credi- 
tors should  not  give  him  a  release  under  an  assignment 
for  the  benefit  of  creditors.  It  is  wrong  to  the  honest  man 
to  give  a  dishonest  man  a  receipt  in  full,  and  allow  him  to 
go  and  benefit  by  his  dishonesty.  It  is  right  under  such 
circumstances  that  he  should  be  put  into  the  bankruptcy 
courts;  and,  moreover,  the  bankruptcy  courts  are  fre- 
quently the  only  place  where  you  can  prove  his  dishonesty. 

Examinations  in  Bankruptcy 

The  bankruptcy  court  is  perhaps  the  only  court  in 
which  it  is  permitted  to  examine  a  wife  against  her  hus- 
band, or  a  husband  against  his  wife.  In  state  courts  you 
cannot  summon  a  wife  to  testify  against  her  husband,  or 
a  husband  to  testify  against  his  wife,  any  more  than  you 
can  subpoena  an  attorney  at  law  to  testify  against  his  own 
client  as  to  communications  between  them.  But  it  is  not 
so  in  bankruptcy. 

Also  in  bankruptcy  any  man  may  be  called  before  the 
court  to  testify  in  relation  to  the  affairs  of  the  bankrupt, 
and  particularly  in  relation  to  his  property,  and  hearsay 
evidence  is  admissible.  This  gives  an  excellent  oppor- 
tunity for  "fishing  excursions."  If  a  man  on  the  street  has 
said  that  he  heard  that  Tom  Jones  said  that  John  Brown 
had  smuggled  away  some  goods,  you  can  call  Jones  and 
ask  him  if  he  said  that,  and  if  he  says,  "Yes,"  you  ask 
him,  "Who  told  you?"  "Well,  it  was  Smith."  Then 
you  may  call  the  other  fellow  and  bring  them  all  in,  and 


232  MERCANTILE  CREDITS 

after  a  while  you  run  the  rumor  to  cover,  and  discover 
either  that  it  is  a  mere  rumor  or  that  it  amounts  to  some- 
thing, in  which  latter  case  you  have  some  clue  that  may 
lead  to  the  discovery  of  the  hidden  goods. 

Grasping  Creditors 

There  are  other  reasons  why  bankruptcy  is  sometimes 
necessary.  Perhaps  an  honest  man  cannot  otherwise  ob- 
tain the  release  to  which  he  is  entitled.  I  have  known 
many  cases  where  the  creditors  as  a  whole  did  not  wish  to 
throw  the  debtor  into  bankruptcy,  but  some  one  creditor 
believed  that,  by  refusing  to  agree  to  an  amicable  adjust- 
ment, he  would  force  the  other  creditors  to  pay  him  one 
hundred  cents  on  the  dollar,  to  get  him  out  of  the  way. 
He  figures  that  his  claim  is  small,  while  the  aggregate  of 
the  other  creditors'  claims  is  large;  and  to  put  the  debtor 
into  bankruptcy  would  mean  a  loss  to  them  of  more  than 
his  whole  claim;  and  so  he  will  not  come  into  the  settle- 
ment. We  meet  with  such  people  every  day.  Of  course, 
if  such  men  find  out  that  you  will  not  be  coerced  into  pay- 
ing them  out,  they  will  not  cause  much  trouble.  But  some- 
times the  creditors,  in  their  eagerness  to  save  from  bank- 
ruptcy some  man  who  does  not  deserve  that  punishment, 
or  to  save  themselves  the  serious  loss  which  a  failure  en- 
tails, mistakenly  pay  such  a  claim  just  to  get  it  settled, 
and  the  successful  bluffer  tells  another,  "I  held  them  up; 
they  paid  me  in  full,"  and  the  result  is  that  a  regular  crop 
of  those  fellows  comes  along. 

Composition 

Now,  bankruptcy  will  compel  each  person  to  take 
what  is  offered.  You  know  we  have  such  a  thing  as  com- 
position in  bankruptcy.  A  man  who  goes  into  bankruptcy 
does  not  necessarily  have  all  his  property  sold  out.  He 


BANKRUPTCY  233 

may  go  into  bankruptcy  and  propose  an  honest  composi- 
tion, and,  if  the  majority  in  number  and  amount  of  credi- 
tors petition  the  court  to  allow  it,  the  court  will  decree 
that  he  is  entitled  to  it.  Whatever  the  settlement  may  be, 
the  balance  of  the  creditors  are  bound  by  it;  and  so  the 
honest  man  gets  his  due. 

Adjustment  Bureaus 

The  credit  man  has  found  that  the  bankruptcy  statute 
is  almost  a  necessity  to  him.  He  must  either  have  bank- 
ruptcy or  an  association  where  voluntary  assignments  can 
be  taken  care  of.  In  Los  Angeles  and  on  the  Pacific  Coast 
generally,  the  boards  of  trade  are  very  well  organized, 
and  most  insolvent  debtors  make  assignments  for  the 
benefit  of  creditors  through  adjustment  bureaus;  but  in 
the  Eastern  states  these  boards  of  trade  did  not  formerly 
exist.  The  National  Association  of  Credit  Men  is  organ- 
izing adjustment  bureaus  in  all  our  great  cities,  but  in  the 
East  it  is  uphill  work  and  the  adjustment  bureaus  are  not 
as  strong  there  as  they  are  here.  In  some  of  the  large 
Eastern  cities  nearly  every  one  who  fails  finally  gets  into 
the  bankruptcy  courts. 

Electing  the  Trustee 

The  most  important  thing  about  a  bankruptcy  estate 
is  to  see  that  the  proper  trustee  is  elected.  I  remember 
the  case  of  a  Chicago  man  who  was  denouncing  the  bank- 
ruptcy statute,  and  when  we  asked  him  why,  told  us  about 
a  claim  of  his  for  $2,000  against  a  man  in  Sioux  City, 
which  he  had  placed  in  the  hands  of  lawyers  there.  He 
could  not  get  any  satisfaction  out  of  his  lawyers,  and 
finally  went  himself  from  Chicago,  and  when  he  reached 
Sioux  City  found  that  the  lawyers  who  represented  him 
also  represented  about  $20,000  of  claims  belonging  to 


234 


MERCANTILE  CREDITS 


the  bankrupt's  mother,  father,  sisters,  and  brothers.  His 
own  claim,  added  to  these,  had  helped  to  elect  the  trustee, 
who  was  a  brother  of  one  of  the  attorneys. 

The  Chicago  man  investigated  the  whole  matter  per- 
sonally and  came  to  the  conclusion  that  all  those  family 
claims  should  have  been  thrown  out.  Because  this  was 
not  done  he  was  denouncing  the  whole  bankruptcy  law, 
but  the  trouble  was  with  the  trustee.  Now,  if  the  credi- 
tors, or  the  credit  men,  would  see  to  it  that  their  claims 
were  properly  voted  in  bankruptcy  for  a  proper  trustee, 
the  bankruptcy  statute  would  not,  I  think,  be  in  such  dis- 
favor. 

The  Referee 

Perhaps  it  may  be  well  to  explain  the  difference  be- 
tween the  referee  and  the  trustee.  The  referee  in  bank- 
ruptcy is  practically  the  court.  The  bankruptcy  statute 
used  two  phrases — "the  judge,"  and  "the  court."  The 
word  "judge"  is  used  a  few  times  in  the  statute,  but  gen- 
erally the  word  "court"  is  used.  Now,  as  a  practical 
proposition,  the  court  is  the  referee.  The  judge  is  the 
United  States  district  judge,  who,  in  bankruptcy  proceed- 
ings in  this  district,  does  nothing  except  adjudicate  and 
refer  the  matter  to  a  referee  and  act  as  an  Appellate 
Court.  The  judge,  immediately  upon  the  adjudication, 
refers  it  by  order  of  reference  to  a  "Referee,"  who  then 
becomes  the  court,  and  all  proceedings  in  the  bankruptcy 
case  take  place  before  the  referee,  acting  as  a  judge. 

The  Trustee  Represents  the  Creditors 

The  trustee  is  the  party  elected  by  the  creditors  them- 
selves to  take  charge  of  the  property  of  the  bankrupt,  and 
the  court  has  nothing  to  do  with  this  election.  That  is 
why  credit  men  are  responsible  for  maladministration  in 
bankruptcy  matters  where  it  does  occur. 


BANKRUPTCY  235 

The  referee  calls  a  meeting  after  a  bankruptcy  adju- 
dication, and  sends  notice  to  every  creditor  that  at  a  cer- 
tain time  and  place  there  will  be  elected  a  trustee.  The 
creditors  come  together  accordingly,  and  nominate  Mr. 
Jones  or  Mr.  Smith  for  trustee.  The  court  has  nothing 
to  do  with  it  except  to  approve  their  choice.  The  trustee 
qualifies  by  filing  a  bond,  and  he  becomes  thereby  invested 
with  the  title  to  all  property  of  the  bankrupt  throughout 
the  United  States  of  America. 

Responsibility  of  the  Creditor 

Credit  men  often  simply  file  their  claims  in  the  bank- 
ruptcy courts,  and  then  forget  all  about  them  until  they 
receive  a  check  for  a  dividend;  and  when  it  is  a  small 
dividend,  they  denounce  the  bankruptcy  law.  They  ought 
to  realize  that  they  must  give  some  of  their  time  to  the 
administration  of  the  statute.  Formerly  they  gave  a  great 
deal  of  time  to  the  collection  of  their  bad  accounts;  for  it 
was  a  case  of  first  come,  first  served.  The  man  who 
levied  the  first  attachment  on  a  debtor's  business  was  paid 
in  full,  and  the  man  who  came  along  last  got  nothing.  In 
those  days  the  credit  man  led  a  strenuous  life.  Nowadays 
he  gives  more  time  to  the  granting  of  credit  and  less  to 
the  collection  of  debts,  because  he  knows  that  in  case  of 
bankruptcy  he  will  get  his  share  of  what  there  is.  But  he 
must  realize  that  there  is  a  certain  personal  responsibility 
resting  on  him  for  the  proper  administration  of  the  bank- 
ruptcy law. 

Preferences 

Everything  in  the  administration  of  the  estate  de- 
pends upon  the  trustee.  He  has  every  right  and  every 
obligation  that  the  bankrupt  has;  and  he  also  has  rights 
that  the  bankrupt  has  not.  For  instance,  a  voluntary  pay- 


236  MERCANTILE  CREDITS 

ment  by  a  bankrupt  to  a  favored  creditor  may  be  per- 
fectly good  as  between  the  bankrupt  and  that  creditor; 
but,  under  certain  circumstances,  it  is  absolutely  unfair  to 
the  other  creditors,  and  the  trustee  has  to  consider  not 
only  the  rights  of  the  bankrupt,  but  the  rights  of  creditors, 
and  must  recover  any  unlawful  preferential  payments. 

To  recover  unlawful  preferences  it  is  necessary  to 
throw  the  debtor  into  bankruptcy.  The  ratable  distribu- 
tion of  the  assets  among  the  creditors  is,  in  fact,  one  of 
the  prime  objects  of  the  law.  Now,  you  cannot  recover 
every  preference  that  has  been  given,  but  only  payments 
that  have  been  made  within  four  months  of  the  bank- 
ruptcy, and  then  only  under  certain  conditions.  The  per- 
son receiving  the  payment  must  have  had  reasonable 
cause  to  believe  that  the  debtor  was  insolvent  at  the  time 
he  made  the  payment.  That  is  not  hard  to  prove,  because 
a  person  cannot  shut  his  eyes  when  he  receives  a  payment 
and  simply  say,  "I  won't  investigate,  for  I  don't  want  to 
know  anything  about  the  man's  condition."  Nearly 
all  credit  men  get  caught  at  one  time  or  another  in  that 
way.  They  think,  "Well,  if  I  don't  make  any  investiga- 
tion of  this  thing,  they  cannot  say  I  had  any  reasonable 
cause  to  believe  the  man  was  insolvent." 

It  has  been  said  that  it  would  constitute  reasonable 
ground  for  belief  that  a  usually  well  dressed  fellow  were 
insolvent  if  he  were  met  in  shabby  attire.  If  after  this 
you  should  receive  a  payment  from  him,  it  might  be  held 
an  unlawful  preference  on  the  ground  that  you  had  rea- 
sonable cause  to  believe  the  man  was  insolvent.  In  other 
words,  it  is  your  duty,  when  anything  occurs  to  cause  you 
to  take  notice,  to  investigate  and  find  the  complete  facts. 

I  recall  the  case  of  a  wholesale  merchant  to  whom  an- 
other wholesale  merchant  was  in  debt.  One  day  he  went 
down  to  the  debtor's  place  and  found  no  one  there  but 


BANKRUPTCY  237 

the  clerk.  The  store  contained  some  potatoes,  a  pair  of 
scales,  the  ordinary  office  furniture,  and  so  on.  The 
creditor  asked  the  clerk  where  the  proprietor  was,  and 
the  answer  came,  "He's  been  gone  about  three  days,  and 
I'm  wondering  where  I'm  going  to  get  my  pay  for  my 
work  here."  "Well,  when  do  you  expect  him  back?"  "I 
don't  know."  "Are  you  selling  as  usual?"  "Yes." 
"How  much  will  you  take  for  that  scale?"  "I  think  it's 
worth  $10."  "All  right."  The  creditor  bought  nearly 
everything  in  the  store  and  moved  it  across  the  street  to 
his  own  store. 

When  the  other  creditors  came  to  investigate  they 
found  an  empty  store  and  they  threw  the  debtor  into  bank- 
ruptcy. The  trustee  then  demanded  the  return  of  the 
hundred  and  fifty  dollars'  worth  of  stuff  that  the  whole- 
sale merchant  had  taken  out,  and  the  creditor  who  had 
bought  the  stuff  came  up  to  court  and  said,  "Mr.  So-and- 
so  might  have  been  a  millionaire,  for  all  I  knew.  I 
hadn't  any  knowledge  or  notice  that  he  was  insolvent.  I 
simply  went  down  and  bought  that  stuff  and  credited  it 
on  my  bill."  "But,"  the  court  said,  "you're  a  produce 
man;  you  are  not  selling  scales,  counters,  and  desks,  are 
you?"  "No."  "Then  what  did  you  buy  those  things  for? 
You  bought  them  because  you  wanted  your  bill  paid?" 
"Yes."  "Why  did  you  want  the  bill  paid  so  badly  as 
that?"  "Well,  I  didn't  know  when  that  fellow  was  com- 
ing back."  "Exactly.  Well,  he  didn't  come  back,"  said 
the  Court.  "And  so  you  will  have  to  give  the  goods 
back." 

The  worst  part  of  it  was,  that  in  the  meantime  the 
creditor  had  sold  the  stuff  to  a  second-hand  man  for  about 
$40;  and  when  he  offered  the  trustee  the  $40,  the  trustee 
said,  "No,  I  want  the  value  that  you  took  it  at;  the  amount 
you  paid  for  it."  "Well,  it  wasn't  worth  that."  "Then 


238  MERCANTILE  CREDITS 

why  were  you  buying  it?"  He  answered,  "I  won't  pay 
the  valuation."  But  the  trustee  sued  him  and  he  had  to 
pay  it. 

Now,  that  is  an  illustration  of  the  fact  that  anything 
unfavorable  you  may  hear  about  a  man's  financial  condi- 
tion puts  you  upon  notice  that  that  man  may  be  insolvent. 
If,  in  your  credit  business,  you  find  that  a  man  has  bill 
collectors  after  him ;  if  you  go  into  his  store  and  see  three 
or  four  other  merchants  around  there  after  money;  then 
you  have  reasonable  cause  to  believe  that  man  is  insol- 
vent, and,  if  you  take  money  from  him  to  the  prejudice 
of  his  other  customers  and  he  is  insolvent,  you  will  have 
to  account  for  it,  because,  if  investigation  would  have 
shown  insolvency,  you  are  supposed  to  have  made  the 
investigation. 

Preferred  Claims 

Of  course,  there  are  certain  debts  that  are  properly 
preferred.  Not  every  payment  constitutes  a  preference 
for  which  you  can  throw  a  debtor  into  bankruptcy.  All 
labor  is  given  priority  to  the  extent  of  $300  if  earned 
within  three  months  before  the  filing  of  the  petition,  and 
there  are  other  things  entitled  to  priority,  such  as  taxes, 
costs  of  preserving  the  estate,  costs  of  administration, 
filing  fees,  and  claims  for  debts — all  of  which  are  given 
priority  under  the  laws  of  the  state.  Liens  made  more 
than  four  months  prior  to  the  filing  of  the  petition,  liens 
given  for  a  present  valuable  consideration,  and  payments 
made  without  the  parties  having  any  reasonable  cause  to 
believe  that  the  second  party  was  insolvent  at  the  time, 
are  also  entitled  to  preference.  In  other  words,  not  every 
payment  made  within  four  months  is  void.  For  instance, 
where  there  is  a  present  consideration,  as  when  a  man 
delivers  goods  and  receives  his  payment  for  them,  such 


BANKRUPTCY  239 

payment  does  not  constitute  a  preference.  Or,  if  a  credi- 
tor has  a  claim  against  a  bankrupt,  and  receives  a  pay- 
ment, and  after  receiving  that  payment,  although  he  may 
know  that  the  man  is  insolvent,  gives  him  further  credit 
to  the  extent  of  the  payment  received,  the  courts  will 
allow  that  payment  to  stand.  Such  a  transaction,  if  in 
good  faith,  does  not  injure  the  other  creditors. 

Discharge  in  Bankruptcy 

I  come  finally  to  the  question  of  discharge  in  bank- 
ruptcy. Courts  favor  discharges  in  bankruptcy  for  the 
same  reason  that  they  favor  a  ratable  distribution  of 
assets.  If  you  are  in  court  seeking  to  set  aside  a  prefer- 
ence, seeking  to  recover  something  that  a  creditor  has 
obtained  within  four  months,  or  seeking  to  throw  a  man 
into  bankruptcy,  and  the  court  sees  that  what  you  are 
seeking  is  equitable  and  that,  if  it  is  denied,  some  one 
is  going  to  be  injured,  you  are  two-thirds  through  with 
your  case.  My  own  personal  experience  has  been  of 
this  nature,  and  when  I  go  into  court  I  know  that  I  have 
the  advantage  of  the  man  opposed  to  me,  because  I  repre- 
sent creditors  entitled  to  redress,  and  the  law  favors  the 
ratable  distribution  of  assets. 

On  the  other  hand,  the  law  also  favors  the  discharge 
of  a  bankrupt,  and  it  is  almost  impossible  in  this  jurisdic- 
tion to  have  this  discharge  denied.  It  must  be  an  abso- 
lutely sure  case.  There  must  almost  be  proof  sufficient 
to  convict  in  a  criminal  action  in  order  to  justify  the  court 
in  denying  a  discharge  in  bankruptcy.  I  have  had  some 
of  these  cases  but  not  many.  Knowing  the  reluctance  of 
the  court  to  deny  such  discharges,  I  have  been  compelled 
in  a  great  number  of  cases  to  advise  creditors  not  to  op- 
pose the  discharge,  because  it  would  be  decided  against 
them. 


24o  MERCANTILE  CREDITS 

Grounds  for  Denying  Discharge 

The  statute,  however,  provides  many  grounds  for 
denying  the  discharge.  For  instance,  it  may  be  denied  if 
the  bankrupt  has  committed  an  offense  punishable  by  im- 
prisonment as  provided  by  the  Act;  that  is,  if  he  has,  be- 
fore or  after  his  discharge,  knowingly  and  fraudulently 
concealed  from  the  trustee  any  property  belonging  to  the 
estate  in  bankruptcy,  or  has  made  false  oath  or  account 
in  relation  to  any  proceeding  in  bankruptcy. 

You  see  this  is  very  restricted.  Either  the  bankrupt 
must  have  concealed  his  property,  or  some  of  it,  or  he 
must  have  lied  somewhere  along  in  the  bankruptcy  pro- 
ceeding; otherwise  you  cannot  prove  that  he  has  com- 
mitted an  act  punishable  by  imprisonment.  Now,  this 
does  not  mean  that  a  prosecution  must  follow,  or  that  the 
evidence  must  be  sufficient  to  bring  about  his  conviction 
by  a  jury;  but  you  must  prove  with  reasonable  certainty 
that  he  has  committed  perjury  or  concealed  his  property. 

Destroying  Records 

But  there  are  other  reasons  for  denying  a  man  a  dis- 
charge in  bankruptcy  that  credit  men  should,  perhaps,  pay 
more  attention  to.  A  discharge  may  be  denied  when  the 
bankrupt,  with  intent  to  conceal  his  financial  condition, 
has  destroyed,  concealed,  or  failed  to  keep,  books  of 
account  or  records  from  which  such  condition  might  be 
ascertained.  This  is  not  so  unusual  as  might  be  supposed. 
In  one  case,  the  day  before  he  went  into  bankruptcy,  an 
insolvent  debtor  destroyed  all  the  books  and  papers  from 
which  his  financial  condition  might  be  ascertained,  except 
his  ledger.  That  was  a  very  unfortunate  thing  for  him  to 
do.  He  claimed  that  he  did  it  honestly;  that  he  did  not 
know  it  was  forbidden  by  the  statute;  that  he  did  not  think 
those  records  were  of  any  importance  because  they  were 


BANKRUPTCY  241 

only  his  sales  slips,  check  books,  and  old  checks,  which 
were  ancient  history;  and  that  the  ledger  showed  his  true 
financial  condition.  But,  unfortunately  for  him,  his  credi- 
tors considered  those  records  very  necessary  to  show  what 
had  become  of  a  great  many  thousands  of  dollars  of  his 
assets. 

False  Statements 

A  discharge  may  also  be  denied  when  it  can  be  shown 
that  the  bankrupt  has  obtained  money  or  property  on 
credit  from  any  person  upon  a  materially  false  statement 
in  writing  made  to  such  person  or  his  representative  for 
the  purpose  of  obtaining  such  credit.  This  is  the  "false 
statement  in  writing"  provision;  and  the  time  will  come 
when  no  credit  man  will  give  credit  without  a  statement 
in  writing,  any  more  than  a  bank  would  give  you  a  loan 
today  without  such  a  statement.  When  that  time  comes, 
there  will  be  fewer  discharges  in  bankruptcy.  The  state 
of  California  has  just  passed  the  "False  Statement  in 
Writing  Bill"  for  which  the  Credit  Men's  Association  has 
so  long  been  fighting.  This  provides  that  any  false  state- 
ment in  writing  hereafter  made  by  any  person  in  Cali- 
fornia for  the  purpose  of  obtaining  credit,  given  either 
to  the  commercial  agencies  or  to  the  credit  man,  makes 
the  person  guilty  of  misdemeanor.  This  is  of  great  ad- 
vantage to  the  credit  man,  for  the  man  who  makes  a  false 
statement  hereafter  will  not  only  be  subject  to  punishment 
under  the  state  law,  but  will  be  unable  to  obtain  his  dis- 
charge in  bankruptcy.  Any  false  statement  in  writing 
made  to  any  creditor  may  be  taken  advantage  of  by  any 
other  creditor  in  objecting  to  the  discharge. 

Concealment  of  Property 

Discharge  may  also  be  denied  if,  at  any  time  subse- 
quent to  the  first  day  of  the  four  months  immediately  pre- 


242  MERCANTILE  CREDITS 

ceding  the  filing  of  the  petition,  the  bankrupt  has  trans- 
ferred, removed,  destroyed,  or  concealed,  or  permitted 
to  be  removed,  destroyed,  or  concealed,  any  of  his  prop- 
erty, with  intent  to  hinder,  delay  or  defraud  his  creditors. 

Discharge  Within  Six  Years 

Discharge  may  be  denied  if  the  debtor  has  been 
granted  a  discharge  in  bankruptcy  in  voluntary  proceed- 
ings within  six  years.  In  other  words,  a  man  may  not 
obtain  two  discharges  within  six  years,  provided  the  first 
bankruptcy  was  voluntary.  It  is  therefore  important  for 
the  creditors  always  to  have  a  man  file  a  voluntary  peti- 
tion when  they  can  get  him  to  do  so,  because  it  will  check 
future  activities. 

Contempt  of  Court 

The  final  ground  for  denying  a  discharge  is  the  refusal 
of  the  bankrupt  in  the  course  of  the  proceedings  in  bank- 
ruptcy to  obey  any  lawful  order  of,  or  to  answer  any 
material  questions  approved  by,  the  court.  In  California 
that  does  not  mean  as  much  as  it  does  in  the  East.  It  is  a 
very  frequent  order  of  Eastern  courts  that  a  bankrupt 
shall  produce  property  that  he  has  not  accounted  for. 

Liability  of  Stockholders 

There  is  one  thing  that  credit  men  should  remember: 
The  discharge  of  a  corporation  does  not  discharge  the 
stockholders  from  any  liability  imposed  upon  them  by 
the  statutes.  Every  credit  man  in  California,  when  he 
gives  credit  to  a  corporation,  not  only  considers  the  finan- 
cial responsibility  of  the  corporation,  but  he  also  con- 
siders the  financial  responsibility  of  the  stockholders  of 
that  corporation,  because,  in  this  state,  every  stockholder 
of  a  corporation  is  liable  for  that  proportion  of  its  debts 


BANKRUPTCY  243 

which  his  stock  bears  to  the  whole  amount  of  the  sub- 
scribed capital  stock  of  the  corporation.  If,  therefore,  the 
corporation  is  of  insufficient  financial  responsibility,  and 
the  stockholders  are  well  known  to  be  perfectly  respon- 
sible financially,  the  credit  man  will  immediately  grant  a 
credit  based  on  the  responsibility  of  the  stockholders,  and, 
as  I  said  a  moment  ago,  the  discharge  of  the  corporation 
has  no  effect  whatever  upon  that  liability  of  the  stock- 
holders of  the  corporation. 

Fraudulent  Debts  Not  Discharged 

Certain  debts  are  not  discharged  at  all  in  bankruptcy; 
and  that  is  where  financial  statements  become  of  so  much 
value.  A  credit  or  property  obtained  by  false  represen- 
tations or  under  false  pretenses,  creates  a  debt  that  can- 
not be  discharged  in  bankruptcy.  Sometimes  I  have  won- 
dered that  the  credit  men  do  not  get  together  on  this 
written  statement  proposition  and  absolutely  demand  it. 
It  is  impossible  for  one  individual  wholesale  house  to 
demand  a  statement  in  writing  before  giving  credit  to  its 
customers,  for  such  a  house  would  not  have  any  business. 
If  only  one  bank  in  Los  Angeles  demanded  a  written 
statement,  and  all  the  others  gave  credit  without  it,  the 
bank  demanding  the  statement  would  certainly  lose  some 
customers,  and  a  wholesale  house  following  a  similar 
course  would  lose  still  more.  It  must  be  a  general  agree- 
ment and  arrangement  among  all  of  the  houses  to  require 
written  statements.  Now,  if  a  false  written  statement  is 
given  to  a  house  and  credit  is  granted  upon  that  state- 
ment, the  debt  remains  forever.  A  man  cannot  be  dis- 
charged from  that  obligation.  Although  his  general  dis- 
charge may  be  granted,  yet  that  particular  debt  remains  a 
debt,  and,  if  at  any  time  in  the  future  the  discharged 
bankrupt  acquires  property,  the  debt  may  be  collected. 


244  MERCANTILE  CREDITS 

Reclamation  Proceedings 

Another  proceeding  that  is  not  used  as  much  as  it 
should  be  in  California,  although  it  is  used  frequently  in 
the  East,  is  what  is  known  as  a  reclamation  proceeding. 
If  a  man  makes  a  false  written  statement  to  you,  or  even 
an  oral  statement  that  is  false  in  any  respect,  and  thereby 
obtains  from  you  goods,  those  goods  may  be  reclaimed  if 
they  can  be  found  in  his  possession  at  the  time  of  his 
failure. 

Not  long  ago  a  wholesale  house  in  Los  Angeles  sent 
its  salesman  to  Salt  Lake  City,  and  the  salesman  went 
into  an  establishment  there  supposedly  worth  from 
$75,000  to  $100,000,  and,  after  obtaining  an  order  for 
two  carloads  of  goods  worth  about  $3,500,  said  to  the 
customer,  "Before  shipping  this,  I  would  like  to  have  a 
financial  statement"  The  customer  replied:  "I  have  just 
given  a  financial  statement  to  Dun  and  Bradstreet,  and 
if  you  will  examine  that  statement  I  think  it  will  be  suffi- 
cient." The  Los  Angeles  house  accordingly  got  a  state- 
ment from  either  Bradstreet  or  Dun  before  shipping  the 
goods,  and  that  statement  showed  that  the  Salt  Lake 
house  had  a  net  worth  of  about  $75,000.  The  goods  were 
therefore  shipped;  but  within  a  week  after  their  arrival  in 
Salt  Lake  City  the  purchasing  concern  had  gone  bank- 
rupt. 

The  Los  Angeles  house  immediately  wired  a  firm  of 
attorneys  in  Salt  Lake  City,  asking  whether  the  goods 
were  still  in  the  possession  of  the  bankrupt.  The  lawyers 
reported  that  the  goods  were  still  in  the  house,  and  imme- 
diately reclamation  proceedings  were  commenced  in  Salt 
Lake  City  on  the  ground  that  the  goods  had  been  ob- 
tained under  false  representations  as  to  the  financial 
worth  of  the  concern,  and  the  Los  Angeles  concern  got 
them  back. 


BANKRUPTCY  245 

Future  of  the  Bankruptcy  Law 

I  have  tried  somewhat  briefly  to  give  you  a  general 
idea  of  bankruptcy  proceedings.  I  know  that  the  bank- 
ruptcy statute  is  one  that  will  remain  on  the  books,  one 
that  credit  men  will  have  to  consider  more  and  more  in 
the  granting  of  credit  in  the  future,  and  one  that  will  be 
necessary  for  them  to  study  and  to  understand  thoroughly, 
because  no  man  should  grant  a  credit  without  reference  to 
that  statute. 


CHAPTER  XIII 

INSURANCE  IN  COMMERCIAL  AFFAIRS 
BY  WARREN  C.  KENNEDY 

Insurance  in  its  different  forms  is  steadily  becoming  a 
greater  factor  in  the  business  world,  as  is  evidenced  by 
its  enormous  growth  in  volume  and  the  widening  field  for 
its  varied  activities.  It  is  therefore  one  of  the  important 
collateral  duties  of  the  credit  man  to  obtain  a  proper 
understanding  of  the  principles  of  commercial  insurance. 

Kinds  of  Insurance 

The  three  great  divisions  of  insurance  are  life,  fire, 
and  marine;  but  besides  these  there  are  scores  of  other 
forms  of  greater  or  less  importance,  including  personal 
accident;  health;  employer's  liability;  public  liability; 
steam  boiler  explosion,  fly  wheel,  elevator;  team  liability; 
damage  to  crops  by  hail  or  fire;  plate  glass  breakage, 
sprinkler  leakage;  defective  titles;  earthquake;  cyclone; 
riot  and  strike  damage  by  violence;  burglary;  securities  in 
transit;  luggage  in  transit;  live  stock;  automobile  loss 
from  fire,  theft,  or  in  transportation;  owner's  liability  for 
injury  caused  to  person  or  property;  loss  of  rent  by  fire  or 
defaulting  tenents;  loss  of  leases  by  fire;  loss  of  profits  by 
fire;  physicians'  liability;  credit  indemnity. 

Closely  related  to  the  miscellaneous  insurance  lines 
are  the  departments  of  insurance  companies  dealing  with 
bonds — fidelity,  contractors,  bail,  in  legal  proceedings,  etc. 

246 


INSURANCE  IN  COMMERCIAL  AFFAIRS    247 

Injudicious  Insurance 

As  with  other  things  necessary  and  useful  to  mankind, 
insurance  is  often  misunderstood,  overdone,  or  insuffi- 
ciently done.  Sometimes  it  is  placed  with  an  irrespon- 
sible company  or  where  a  risk  does  not  exist,  and  some- 
times a  real  hazard  is  left  unprotected.  Some  of  us  in- 
sure too  much  and  injudiciously,  others  not  enough  to 
protect  their  business  from  failure  or  their  widows  and 
orphans  from  poverty. 

Importance  of  Preventive  Measures 

Insurance  does  not  create  or  save  wealth,  it  merely 
distributes  the  losses  of  the  few  upon  the  many.  In  other 
words,  all  insurance  losses  are  in  the  end  borne  by  the 
public.  The  guiding  principle  which  should  always  be  in 
evidence  with  any  hazard,  whether  insurable  or  not  in- 
surable,  is  prevention,  intelligently  administered :  fire  pre- 
vention, accident  prevention,  prevention  of  many  perils  of 
the  sea,  of  accidents  to  employees,  of  casualties,  of  credit 
losses,  boiler  explosions,  loss  of  land  from  defective  titles, 
losses  from  dishonest  employees.  Secure  competent  offi- 
cers for  your  ships,  careful  foremen  for  your  laborers, 
safe  machinery  for  your  workmen,  intelligent  credit  men 
for  your  business,  competent  engineers  for  your  boilers, 
reliable  experts  for  your  land  titles,  and  men  of  good 
character  for  positions  of  trust. 

Life  Insurance  for  Firms 

Life  insurance  in  commercial  affairs  is  life  underwrit- 
ing that  a  man  purchases  to  protect  his  business  in  the 
event  of  his  death.  This  is  sometimes  called  partnership 
or  corporation  insurance,  and  in  an  increasing  number  of 
concerns  one  or  more  partners  or  corporation  officials 
are  insured  for  the  protection  of  the  establishment.  The 


248  MERCANTILE  CREDITS 

death  of  an  important  member  of  a  business  house  is  often 
a  great  loss,  and  sometimes  a  calamity,  and  this  risk 
should  receive  the  same  consideration  that  any  other  busi- 
ness misfortune  is  entitled  to,  in  its  relative  degree. 

If  the  important  member  of  a  firm  is  in  bad  health,  no 
insurance  can  be  had.  If  in  good  health  and  under  sixty 
years  of  age,  life  insurance  will  often  protect  a  valuable 
business,  and,  in  turn  and  proportionally,  the  interest  of 
the  deceased  partner's  family  therein.  Business  insur- 
ance will  enable  a  surviving  partner  to  pay  cash  to  the 
deceased  partner's  family  for  its  interest  in  the  busi- 
ness, and  this  arrangement  is  sometimes  contracted  for 
in  articles  of  partnership.  The  advantage  here  in  many 
cases  is  mutual,  the  surviving  partner  being  able  to  pur- 
chase the  deceased  partner's  interest  instead  of  having  the 
latter's  family  dependent  on  dividends  from  the  business 
without  ability  to  assist  in  its  responsibilities;  while  the 
family  receives  under  this  arrangement  the  equivalent  in 
cash  of  its  interest  in  the  business,  and  is  therefore  free 
from  dictation  from  the  surviving  partner  with  whom  it 
may  not  be  in  sympathy. 

Business  insurance  policies  sometimes  run  to  very 
large  amounts.  Some  individuals  are  now  carrying  from 
$1,000,000  to  $4,000,000  of  life  insurance  to  protect 
their  large  interests. 

History  of  Life  Insurance 

Life  insurance  is  an  outgrowth  of  the  friendly  socie- 
ties of  three  centuries  ago,  and  these  societies  in  turn 
followed  certain  trade  and  religious  guilds  which  have 
had  existence  in  European  and  Asiatic  civilization  for 
thousands  of  years. 

The  frequent  need  of  assistance  to  bury  the  dead  prob- 
ably gave  origin  to  a  system  of  organized  aid  in  families 
or  localities ;  and  this  has  developed  into  a  large  plan  for 


INSURANCE  IN  COMMERCIAL  AFFAIRS    249 

mutual  contributions  from  the  many,  and  thereby  built  up 
the  enormous  trust  funds  now  held  by  life  insurance  com- 
panies with  policies  aggregating  in  the  United  States  over 
twenty-six  billion  dollars. 

In  1698  the  Mercers  Company  in  London  undertook 
to  furnish  annuities  for  the  widows  of  clergymen;  but  the 
Amicable  Society  of  London,  founded  in  1706,  was  the 
first  general  life  assurance  institution  ever  established. 
However,  little  was  accomplished  before  the  organiza- 
tion of  the  Equitable  Life  Assurance  Society  in  1762.  This 
old  company  is  still  operating  in  London;  has  assets  of 
$25,000,000,  and  transacts  its  business  without  payment 
of  commission  to  agents.  This  practice  permits  of  a  small 
percentage  of  expense,  but  limits  the  usefulness  of  the 
institution  to  a  comparatively  small  field  as  compared 
with  the  commission  paying  companies,  for,  as  we  all 
know,  it  is  human  nature  for  the  majority  of  men  not  to 
insure  unless  actively  solicited  to  do  so. 

In  the  United  States  the  first  Freemason's  Lodge  was 
established  in  Boston  in  1733 ;  and  later  organized  benev- 
olence led  to  a  clergymen's  insurance  society  in  1759. 
Numerous  other  enterprises  of  a  similar  nature  were 
started  before  a  successful  and  permanent  life  underwrit- 
ing company  was  launched.  The  great  Mutual  Life  In- 
surance Company  was  established  in  1842,  and  its  success 
led  to  the  formation  of  several  important  competing  com- 
panies. Massachusetts  established  the  first  insurance  de- 
partment in  1855,  and  in  Elizur  Wright,  insurance  com- 
missioner, found  a  master  mind  whose  ability  and  writ- 
ings wrought  sound  principles  and  a  scientific  system  out 
of  the  loose  practices  which  had  been  prevalent.  The 
laws  regarding  life  insurance  have  been  repeatedly  revised 
in  the  interests  of  the  policy  holders  so  that  these  now 
have,  under  all  circumstances,  an  equity  in  premiums  paid. 


250  MERCANTILE  CREDITS 

Assessment  Societies 

An  important  feature  in  American  life  insurance  has 
been  the  great  growth  of  assessment  societies.  Their 
success  has  been  mostly  with  men  ignorant  of  insurance, 
and  attracted  solely  by  the  low  cost.  Unfortunately, 
many  of  these  societies  have  been  in  unskilled  or  un- 
scrupulous hands,  resulting  in  a  large  percentage  of 
failures,  with  many  families  left  unprotected  when  most 
in  need.  Probably  the  most  successful  association  of  this 
character  was  that  which  recently  discontinued  the  taking 
of  more  risks  on  an  assessment  basis,  and  adopted  the 
methods  of  the  "old  line"  companies  for  all  its  new  busi- 
ness because  of  the  uncertainties  of  the  assessment  plan. 

For  business  or  corporation  insurance,  assessment 
societies  do  not  appear  to  be  available. 

Amount  of  Life  Insurance  in  the  United  States 

In  1909,  life  policies  and  certificates  in  the  United 
States  numbered  36,500,000,  amounting  to  $25,175,797,- 
538,  while  in  all  the  rest  of  the  world  life  policies  in  force 
amounted  to  only  $8,742,509,421,  showing  that  the 
United  States  has  in  force  three-quarters  of  the  life  in- 
surance of  the  world. 

History  of  Marine  Insurance 

This  is  the  oldest  and  most  complex  form  of  insur- 
ance, and  is  doubtless  the  least  understood  by  the  ordinary 
purchaser.  A  kind  of  indemnity  for  marine  losses  in  the 
form  of  loans  was  practiced  by  the  ancient  Greeks  and 
was  fully  described  by  Demosthenes  about  350  B.  C. 
Money  was  advanced  on  a  ship  or  cargo  to  be  repaid 
with  large  interest  if  the  voyage  prospered,  but  not  to  be 
repaid  at  all  if  the  ship  were  lost.  Eight  centuries  later, 
A.  D.  533,  the  Roman  Emperor,  Justinian,  enacted  laws 
regulating  the  rate  of  interest  to  be  paid  on  such  loans. 


INSURANCE  IN  COMMERCIAL  AFFAIRS     251 

Marine  insurance  was  probably  practiced  in  France 
in  1182,  having  evidently  been  adopted  from  a  practice 
established  in  Italy.  In  England  it  was  in  active  use  in 
1555,  over  a  century  before  fire  insurance  was  established; 
and  in  Queen  Elizabeth's  time  the  British  Parliament  de- 
clared it  to  have  existed  from  time  immemorial. 

Modern  English  and  American  marine  insurance  law 
is  largely  based  on  the  rules  and  principles  laid  down  by 
William  Murray  (Lord  Mansfield),  presiding  justice  in 
the  Court  of  Kings  Bench  from  1756  to  1788.  The  con- 
summate ability  of  this  masterly  jurist  has  caused  him  to 
be  regarded  as  the  founder  of  modern  commercial  law,  of 
which  insurance  law  is  only  an  important  part. 

Nature  of  Marine  Insurance 

Marine  insurance  is  a  contract  by  which  the  under- 
writer agrees  for  a  premium  to  protect  the  assured  against 
loss  arising  from  certain  perils  or  sea  risks  to  which  a  ship 
or  merchandise  may  be  exposed  during  a  specific  voyage 
or  period  of  time.  Losses  are  divided  into  three  general 
classes: 

(1)  Claims  for  total  losses. 

(2)  Claims  for  general  average. 

(3)  Claims  for  particular  average. 

General  Average 

The  terms  general  and  particular  average  are  obscure 
and  confusing  to  the  layman;  and,  on  account  of  the  end- 
less variety  of  sacrifices  and  accidents  which  occur  to 
vessels  of  the  merchant  marine  and  their  cargoes,  even 
admiralty  lawyers,  judges,  and  juries  find  difficulty  at 
times  in  determining  the  correct  classification  of  losses 
subject  to  litigation. 

Defined  briefly,  general  average  is  a  loss  by  sacrifice. 


252  MERCANTILE  CREDITS 

Particular  average  is  a  loss  by  accident.  Common  forms 
of  general  average  sacrifices,  which  must  be  voluntary, 
are  as  follows:  throwing  cargo  overboard  to  save  the 
ship;  damage  to  the  unburned  cargo  by  water  poured 
over  it  to  extinguish  a  fire;  loss  or  damage  to  ship  or 
cargo  by  the  voluntary  stranding  of  the  vessel  for  the 
common  safety. 

The  theory  of  a  general  average  loss  or  sacrifice  is 
simple  enough.  For  instance,  we  will  assume  that  you  are 
the  owner  of  100  barrels  of  cement  on  a  vessel  in  distress 
at  sea.  For  the  safety  of  the  vessel  and  balance  of  cargo, 
all  your  cement  is  thrown  overboard,  and  the  ship  and 
other  cargo  thereby  saved.  It  is  only  common  justice  that 
you  should  be  reimbursed  for  your  loss  by  a  pro  rata  con- 
tribution from  the  ship  and  cargo  saved  by  the  sacrifice  of 
your  cement. 

When  a  shipper  holds  the  proper  form  of  policy,  the 
marine  insurance  company  takes  care  of  his  interest  by 
paying  the  contributions  levied  upon  him  for  general 
average. 

Particular  Average 

While  general  average  represents  a  voluntary  loss  by 
sacrifice,  particular  average  signifies  the  damage  to,  or 
partial  loss  of,  ship  or  cargo  by  some  fortuitous  or  un- 
avoidable accident,  and  includes  every  form  of  loss  that 
is  not  a  total  loss  or  a  general  average  sacrifice. 

If  a  ship  takes  fire,  and  water  is  poured  into  the  hold 
to  extinguish  the  fire,  the  cargo  damaged  by  the  water 
would  be  a  general  average  loss,  this  being  a  sacrifice; 
but  the  cargo  damaged  by  fire  only  would  be  a  particular 
average  loss,  because  the  damage  from  that  cause  was 
accidental. 

The  usual  marine  policy  covers  total  and  general 


INSURANCE  IN  COMMERCIAL  AFFAIRS    253 

average  losses,  and  is  known  as  the  "Free  of  Particular 
Average"  policy,  meaning  that  the  underwriter  is  not  re- 
sponsible for  particular  average  losses.  Another  policy 
with  a  necessarily  higher  premium  rate  is  known  as  the 
"Particular  Average"  policy,  and  covers  total,  general, 
and  particular  average  losses. 

Lloyds 

Closely  associated  with  the  development  of  the  British 
merchant  marine,  and  with  marine  insurance  the  world 
over,  is  Lloyds — a  corporation  having  as  its  particular 
objects,  first,  the  writing  of  marine  insurance;  second,  the 
protection  of  the  interests  of  the  members  of  the  associa- 
tion; and  third,  the  collection,  publication,  and  diffusion 
of  intelligence  and  information  with  respect  to  shipping. 

This  association  of  merchants,  ship  owners,  under- 
writers, and  brokers  had  its  origin  in  a  seaman's  coffee 
house  established  by  an  enterprising  man  named  Edward 
Lloyd,  first  heard  of  in  the  year  1688.  It  was  his  system- 
atic gathering  of  maritime  information  which  made  his 
coffee  house  the  principal  meeting  place  for  those  inter- 
ested in  merchant  marine  affairs,  and  from  this  beginning 
has  grown  one  of  the  greatest  organizations  of  the  com- 
mercial world. 

Fire  Insurance 

Fire  insurance  is  the  most  familiar  branch  of  under- 
writing to  the  merchant,  manufacturer,  and  banker,  many 
of  whom  have  no  dealings  in  marine  insurance,  and  but 
little  acquaintance  with  the  life  policy.  While  history 
shows  that  for  2,500  years  efforts  have  been  made  to 
relieve  sufferers  from  fire  by  some  form  of  public  contri- 
bution, fire  insurance  in  the  sense  known  to  us,  was  begun 
in  London  in  the  year  following  the  great  fire  of  1666.  In 


254  MERCANTILE  CREDITS 

this  conflagration,  85  per  cent  of  the  buildings  of  the  city 
were  destroyed,  with  a  loss  of  about  ten  million  pounds, 
equal,  it  has  been  estimated,  to  three  hundred  million 
dollars  in  our  day.  There  was  no  insurance,  and  the 
great  metropolis  did  not  recover  from  the  effect  for  a 
number  of  years. 

It  might  be  well  here  to  compare  this  with  the  San 
Francisco  fire  of  1906.  The  Chamber  of  Commerce  re- 
port states  that  about  3,000  acres  were  burned  over,  con- 
taining 520  blocks  of  about  25,000  buildings,  with  a  loss 
of  nearly  $350,000,000  and  insurance  approximately 
$235,000,000.  The  benefits  of  insurance  are  here  clearly 
shown.  The  general  ratio  of  insurance  to  the  value  of 
property  destroyed  was  thus  about  70  per  cent. 

In  1910  there  were  in  the  United  States  fire  insurance 

companies  of  all  kinds,  to  the  number  of 624 

With  total  assets  of $580,600,192 

Annual  income 295,644,7 1 5 

Annual  expenditures 256,681,453 

Risks  written 36,357,713,046 


Average  rate $1.0822 

Insurance  Rates 

Insurance  rates  are  necessarily  based  on  the  character 
of  the  risk.  A  dry  cleaning  establishment  using  benzine 
and  gasoline  constantly,  located  in  a  frame  building  and 
exposed  to  hazard  of  fire  from  adjoining  buildings,  may 
have  a  rate  of  six  to  ten  per  cent,  and  even  then  some  com- 
panies will  not  take  the  risk.  Non-inflammable  materials, 
however,  kept  in  sprinklered,  fireproof  buildings,  not  ex- 
posed to  fire  from  neighboring  buildings,  have  been  in- 
sured at  a  cost  of  about  one-tenth  of  one  per  cent.  Be- 
tween these  two  extremes  the  rates  vary  directly  with  the 
conditions. 


INSURANCE   IN   COMMERCIAL  AFFAIRS     255 

The  California  Form  of  Policy 

In  California  since  the  San  Francisco  conflagration  of 
1906,  the  law  requires  that  only  the  California  form  of 
policy  be  used.  This  is  a  modification  of  the  standard 
form  of  policy  of  the  State  of  New  York,  which  became 
mandatory  for  use  in  that  state  in  1887.  It  was  carefully 
prepared,  and,  while  not  a  perfect  instrument,  it  is  ac- 
knowledged to  be  the  best  form  ever  generally  used.  Bil- 
lions of  dollars  of  contracts  have  been  written  on  it,  and 
many  legal  decisions  have  established  its  meaning  and  its 
substantial  fairness  to  all  concerned.  It  is  an  instrument 
of  2,536  words,  and  is  written  in  plain,  non-technical 
language. 

It  should  not  be  necessary  to  caution  business  men  to 
see  that  their  property  is  properly  described  in  the  policy, 
yet  many  are  lax  in  this  respect,  and  local  agents  are  fre- 
quently more  anxious  to  sell  a  policy  than  to  describe 
properly  that  which  the  insurance  is  intended  to  cover. 

Co-insurance 

A  co-insurance  clause  is  a  part  of  all  policies  issued  in 
France,  Germany,  and  some  other  European  countries, 
but  is  not  yet  general  in  Great  Britain  and  the  United 
States.  Ten  of  our  states  prohibit  a  co-insurance  clause, 
and  many  objections  have  been  made  to  this  form  of 
policy,  but  insurance  experts  generally  are  in  favor  of  it 
as  being  a  step  toward  a  more  correct  scientific  rating. 
An  able  writer  speaks  of  co-insurance  as  follows : 
"The  direction  in  which  fire  insurance  calls  most  press- 
ingly  for  improvement  is  the  extension  of  the  principle  of 
co-insurance.  The  importance  of  this  can  be  understood 
only  by  remembering  that  the  aggregate  losses  of  the 
community  by  fire  are  chiefly  made  up  of  innumerable 
small  fires  and  not  of  sweeping  conflagrations.  The  ex- 


256  MERCANTILE  CREDITS 

perience  of  every  company  confirms  the  general  truth,  that 
the  number  of  fires  in  which  a  building  is  totally  destroyed, 
or  in  which  the  loss  amounts  to  the  greater  part  of  the 
property  exposed  under  the  same  risk,  is  comparatively 
very  small.  It  may  be  asserted  with  confidence  that  in  the 
grand  aggregate  of  the  business,  much  more  than  three- 
fourths  of  the  loss  occurs  in  fires  in  which  less  than  one- 
tenth  of  the  insurable  value  at  risk  is  destroyed. 

"In  an  equitable  adjustment  of  rates,  the  amount  in- 
sured, as  compared  with  the  value  exposed,  is  a  prime 
element;  and  premiums  might  justly  form  a  scale  highest 
on  the  smallest  fractions  of  value  and  diminishing 
rapidly  as  the  percentage  of  insurance  increases. 

"The  correct  principle  is,  that  when  a  proper  rate  for 
a  class  of  risks  is  found,  the  insured  may  protect  at  this 
rate  any  percentage  of  such  risk,  and  in  case  of  fire  shall 
be  indemnified  for  the  same  percentage  of  his  loss. 

"The  American  clause  provides:  'If  at  the  time  of  fire 
the  whole  amount  of  insurance  on  the  property  covered 
by  this  policy  shall  be  less  than  80  per  cent  of  the  actual 
cash  value  thereof,  this  company  shall  be  liable  only  for 
such  portion  of  such  loss  or  damage  as  the  amount  in- 
sured by  this  policy  shall  bear  to  the  said  80  per  cent  o£ 
the  actual  cash  value  of  such  property.' 

"The  most  serious  objection  to  this  system  is  the  fact 
that  a  fire  may  promise  profit  to  the  insured.  The  cor- 
dial support  of  the  mercantile  community  in  the  great 
cities  and  of  the  most  intelligent  state  officers  has  been 
given  to  it." 

Conflagration  Loss 

The  great  problem  of  the  fire  companies  is  the  con- 
flagration loss.  This  factor  must  receive  attention  from 
the  insurer  as  well.  To  secure  proper  protection  he 


INSURANCE   IN   COMMERCIAL  AFFAIRS     257 

should  select  companies  who  from  their  history  have 
established  a  satisfactory  record  for  care  in  assuming  con- 
flagration risks,  and  a  good  reputation  for  settling  losses. 

Probably  the  best  guide  we  have  in  that  respect  in  fire 
insurance  is  the  report  of  the  special  committee  of  the 
Chamber  of  Commerce  of  San  Francisco  on  settlements 
incidental  to  the  San  Francisco  fire.  The  National  Asso- 
ciation of  Credit  Men  also  published  a  somewhat  similar 
report,  and  from  these  we  learn  which  companies  met 
their  losses  honorably,  and  which  took  advantage  of  the 
insurer  by  unfair  settlements. 

As  long  as  the  Roll  of  Honor  Companies  are  avail- 
able to  you  they  should  receive  your  business.  The  sacri- 
fices these  companies  made  in  the  dark  days  of  1906  in 
San  Francisco  should  bear  fruit  in  our  support  for  many 
years  to  come. 

Employers'  Liability  Insurance 

Employers'  liability  and  workmen's  compensation  in- 
surance is  an  important  development  of  the  present  gen- 
eration, and  is  largely  the  outgrowth  of  the  English  Em- 
ployers' Liability  Act  of  1880.  This  was  followed  by  a 
similar  act  passed  by  the  Massachusetts  legislature  in 
1887,  and  other  states  have  been  continually  passing  and 
amending  the  liability  statutes  ever  since. 

The  nations  of  Europe  have  gradually  abandoned  the 
principle  of  law  that  required  the  employee  to  prove 
negligence  in  order  to  secure  damages.  This  old  rule  has 
for  generations  worked  the  greatest  hardship  to  those 
least  able  to  bear  it.  The  average  laboring  man  when 
seriously  injured  is  in  no  position  to  conduct  a  successful 
suit  for  damages  against  an  employer  of  means,  of 
greater  experience,  and  who  probably  has  more  able  legal 
advisers.  In  the  event  of  the  death  of  the  employee,  his 


258  MERCANTILE  CREDITS 

widow  and  children  are  even  more  helpless.  In  either  case 
the  victim's  needs  and  expenses  are  multiplied  by  hospital 
and  surgeons'  bills,  and  his  income  is  ordinarily  absolutely 
cut  off.  The  tendency  of  the  times  is  clearly  to  place  the 
burden  of  expense  for  accidents  upon  the  industry  itself, 
first  by  employers'  liability  laws  and  now  by  workmen's 
compensation  laws  or  compulsory  insurance. 

California's  first  step  in  this  direction  was  the  adop- 
tion of  the  Roseberry  liability  and  compensation  law, 
which  became  effective  on  September  ist,  1911,  and  was 
in  force  until  the  close  of  1913.  This  law  was  optional  in 
allowing  the  employer  to  take  his  choice  of  electing  to 
conform  to  its  provisions  and  limiting  his  liability  accord- 
ing to  its  schedule,  or  assuming  the  liability  of  the  old 
common  law  which  has  no  limitation.  Only  a  small  pro- 
portion of  the  employers  of  the  state  have  elected  to  come 
within  the  provisions  of  the  Roseberry  law,  so  that  less 
than  ten  per  cent  of  the  working  population  today  come 
under  the  compensation  features  of  the  act. 

On  January  ist,  1914,  the  Roseberry  law  was  suc- 
ceeded by  the  Boynton  Workmen's  Compensation  Insur- 
ance and  Safety  Act,  which  for  the  first  time  in  California 
introduces  compulsory  compensation — excepting  in  agri- 
cultural pursuits  and  to  domestic  servants — for  all  acci- 
dents to  employees  resulting  in  more  than  two  weeks'  dis- 
ability, and  this  compensation  must  be  paid  by  the  em- 
ployer regardless  of  who  is  at  fault. 

Such  advanced  legislation  with  its  new  and  serious 
problems  will  probably  result  in  a  greater  necessity  than 
ever  for  insurance  to  cover  the  increased  obligations  of 
employers,  making  a  knowledge  of  the  accompanying 
insurance  problems  especially  important. 

The  Boynton  Act  was  really  the  work  of  the  Cali- 
fornia Industrial  Accident  Board,  which  body  advised  the 


INSURANCE  IN  COMMERCIAL  AFFAIRS    259 

state  legislature  that  the  rates  of  the  employers'  liability 
insurance  companies  for  workmen's  compensation  under 
the  Roseberry  law  were  excessive,  and  the  board  asked 
the  legislature  to  establish  a  state  insurance  fund,  begin- 
ning with  the  operation  of  the  new  law,  to  afford  em- 
ployers' insurance  at  reasonable  rates.  The  legislators 
accepted  the  recommendation  of  the  board,  and,  not- 
withstanding the  most  bitter  opposition  of  employers' 
liability  insurance  companies,  the  bill  was  passed,  includ- 
ing a  provision  for  a  competitive  state  insurance  fund  and 
a  state  rate-making  bureau  with  power  to  name  liability 
insurance  rates,  just  as  the  railroad  commission  can  dic- 
tate freight  rates. 

The  purpose  of  the  legislature  in  passing  this  statute 
was  to  reach  a  great  social  and  economic  problem — the 
third  greatest  cause  of  poverty. 

The  four  great  causes  of  poverty  are : 

1 i )  Sickness. 

(2)  Lack  of  employment. 

(3)  Industrial  accidents. 

(4)  Death  of  the  father  before  his  children  have 

become  self-supporting. 

In  the  important  work  of  relieving  the  distress  of 
this  third  cause,  it  is  the  aim  of  the  proponents  of  the 
Industrial  Accident  Law  to  place  upon  the  consumer  the 
cost  of  providing  a  moderate  compensation  to  injured 
employees  and  their  dependents;  and  it  is  claimed  that 
California  has  the  best  compensation,  insurance,  and 
safety  act  in  the  world.  Even  though  every  employer 
should  expect  to  add  the  insurance  cost  to  the  selling  price 
of  his  wares,  as  he  would  in  the  event  of  an  increase  of 
freight  rates,  the  situation  which  many  of  them  confront 
with  the  new  year  offers  an  interesting  problem  to  the 
student  of  insurance. 


26o  MERCANTILE  CREDITS 

Public  Liability  Insurance 

Public  liability  insurance  is  a  direct  outgrowth  of  em- 
ployers' liability  insurance  and  is  written  to  protect  the 
employer  in  case  of  accident  to  third  parties  caused  by  his 
employees.  In  some  industries  this  is  a  considerable  risk, 
as,  for  instance,  with  building  contractors.  It  is  not  un- 
usual to  read  of  serious  accidents  to  employees  of  one 
contractor  caused  by  the  employees  of  another,  especially 
in  the  case  of  persons  who  are  working  several  stories 
below  others. 

The  same  principle  covers  vehicle  and  team  insurance, 
giving  protection  in  the  event  of  damage  caused  to  third 
parties  by  runaway  or  collision. 

Steam  Boiler  Insurance 

Steam  boiler  insurance  as  conducted  in  this  country 
since  1866,  carries  with  it  the  very  useful  periodical  in- 
spection of  the  boiler,  on  which  the  owner  generally  relies 
to  keep  him  informed  as  to  its  safety;  and  it  is  a  fact  that 
manufacturers  of  boilers  are  glad  to  carry  this  insurance 
on  boilers  in  their  own  service  so  that  expert  inspectors 
can  be  relied  on  to  make  a  regular  examination  and  re- 
port. In  spite  of  this  care,  however,  there  have  been  re- 
ported in  the  last  forty-one  years  10,501  boiler  explosions 
in  the  United  States,  Canada,  and  Mexico,  causing 
10,884  deaths  and  injury  to  15,634  other  persons. 

The  usual  policy  for  a  single  boiler  is  for  a  maximum 
liability  of  $5,000  written  for  three  years  at  one  per  cent, 
or  $50,  for  the  term.  While  fire  insurance  will  carry  a 
higher  rate  for  a  hazardous  risk  in  practice,  no  insurance 
can  be  had  for  any  sum  on  a  boiler  regarded  as  unsafe, 
and  an  owner  would  surely  be  liable  for  damages  on  the 
ground  of  negligence  for  any  accident  following  the  using 
of  a  boiler  condemned  as  unsafe  by  a  qualified  inspector. 


INSURANCE  IN  COMMERCIAL  AFFAIRS    261 

Personal  Accident  Insurance 

Personal  accident  is  an  important  division  of  casualty 
insurance,  but  does  not  often  enter  into  commercial  affairs. 
I  see  no  reason  why  it  should  not  be  considered  a  valuable 
form  of  business  insurance  in  the  same  way  as  is  life  in- 
surance, though  necessarily  to  a  more  limited  extent.  As 
business  insurance,  the  weekly  indemnities  should  be 
dropped,  and  the  policy  carried,  perhaps,  on  the  life  risk 
only.  The  premium  for  this  is  only  $2.50  per  thousand 
per  annum,  so  that  a  $20,000  policy  would  cost  only  $50 
a  year. 

Accident  insurance  was  begun  in  England  in  1849  f°r 
insuring  against  the  consequences  of  railway  accidents. 
In  1856  all  kinds  of  accidents  were  included  in  one  policy, 
and  premiums  were  based  on  the  hazard  estimated  to 
follow  one's  occupation. 

Credit  Insurance 

Credit  insurance  has  never  become  an  important  gen- 
eral factor  in  business.  I  know  of  but  two  companies — one 
American  and  one  English — operating  in  the  United 
States,  and  only  one  of  these  is  represented  on  the  Pacific 
Coast.  In  the  operations  of  these  companies  during  about 
1 7  years  to  1911,  they  received : 

In  premiums $36,590,727.02 

And  paid  for  losses $16,815,780.63 

This  is  a  loss  ratio  of  46  per  cent,  which  is  fair  to  in- 
surers if  the  business  is  properly  conducted.  The  pre- 
miums of  the  two  companies  for  1910  amounted  to 
$1,434,987.43;  and  losses  paid  during  the  year  were 
$784,618.63,  or  nearly  55  per  cent. 

Credit  insurance  does  not  insure  a  man  for  his  total 
loss,  as  the  contracts  are  written  to  insure  against  ab- 


262  MERCANTILE  CREDITS 

normal  losses  only.  This  is  arranged  by  providing  in  the 
contract  that  a  usual  loss — of,  say  y2  of  i  per  cent  of 
annual  sales — should  be  borne  by  the  insurer.  This  is 
called  the  "own"  loss.  If  the  loss  for  the  following  year 
is  i  per  cent,  the  insuring  company  would  pay  the  differ- 
ence only  between  the  "own"  loss  of  ^  of  i  per  cent  and 
the  actual  loss  of  i  per  cent. 

On  sales  for  the  year  of $1,000,000.00 

A  i  per  cent  loss  would  figure. .  .  10,000.00 
An  "Own"  loss  of  ^  of  i  per  cent 

would  be 5,000.00 

And  the  insurer  would 

recover  the  balance  of 5,000.00 

Always  provided  that  the  balance  did  not  exceed  the 
amount  of  his  policy. 

Credit  insurance  has  not  yet  established  a  firm  hold  on 
business,  as  its  average  losses  paid  of  less  than  $1,000,000 
a  year  would  prove.  The  capital  invested  is  not  large, 
and  on  the  Pacific  Coast  there  appears  to  be  no  competi- 
tion, doubtless  owing  to  the  difficulty  of  introducing  the 
business.  The  credit  losses  reported  by  the  mercantile 
agencies  run  over  $150,000,000  a  year,  yet  these  insur- 
ance companies  do  not  cover  i  per  cent  of  the  reported 
losses.  There  is  merit  in  the  theory;  but  the  practice  is 
difficult  to  work  out. 

How  to  Insure 

The  problem  of  concentrated  and  scattered  risks  is 
often  confronted.  Many  wealthy  concerns  with  suffi- 
ciently scattered  risks  carry  the  hazard  themselves  with- 
out insurance.  This  is  thoroughly  businesslike  when  the 
losses  cannot  be  severe,  and  the  risks  are  unquestionably 
small  and  scattered.  Many  houses  insure  their  concen- 


INSURANCE  IN  COMMERCIAL  AFFAIRS     263 

trated  risks  and  assume  their  several  scattered  risks.  A 
mill  may  be  insured  to  a  large  amount;  but  its  separated 
buildings  for  offices,  power  house,  stables,  garage,  store- 
houses and  shops,  may  properly  bear  no  insurance  if  no 
great  value  is  at  risk  in  each,  and  they  are  safely  pro- 
tected from  a  general  fire. 

Every  concern  carries  some  risks;  for  no  one  would 
take  policies  to  protect  from  every  possible  danger.  The 
important  question  is  as  to  the  most  businesslike  method 
to  pursue.  The  necessity  for  carrying  substantial  insur- 
ance on  our  larger  risks  is  usually  imperative,  but  the 
wealthier  the  concern  becomes  and  the  more  distributed 
its  hazards,  the  more  it  can  afford  to  carry  its  own  insur- 
ance. This  applies  in  practically  every  line. 

If  a  wealthy  concern  has  several  men  who  may  be 
competent  to  manage  it,  the  house  may  not  need  business 
life  insurance.  If  several  trained  men  are  not  available, 
life  insurance  should  be  considered. 

The  cost  of  employers'  liability  insurance  to  a  large 
employer  will  frequently  justify  him  in  using  the  same 
amount  of  money  to  make  his  own  settlements  with  his 
men;  whereas  to  a  small  company  the  amount  at  risk 
might  be  too  great. 

Some  of  the  great  steamship  companies  are  themselves 
carrying  a  large  proportion  of  the  marine  risk,  as  their 
many  ships  are  widely  scattered.  This  was  true  with  the 
owners  of  the  Titanic.  Some  people  thoughtlessly  as- 
sume that  everything  should  be  covered  by  insurance,  for- 
getting that  insurance  is  a  considerable  expense,  and  that, 
if  this  expense  can  be  saved,  the  savings  will  cover  many 
of  the  ordinary  risks  of  the  business.  The  business  men 
who  do  not  insure  their  large  risks  from  fire  are,  however, 
happily  growing  more  rare,  and  partly  for  the  reason  that 
they  cannot  secure  due  credit  consideration  unless  they  do. 


264  MERCANTILE  CREDITS 

Defective  Policies 

There  have  been  many  cases  of  improperly  written 
policies  with  wrong  or  defective  descriptions,  in  which  the 
insurance  companies  have  assumed  that  the  policies  meant 
something  else,  and  have  paid  the  bill.  In  another  in- 
stance, an  acquaintance  of  mine  conducted  a  business  as 
a  partnership  and  forgot  to  transfer  his  insurance  when 
he  incorporated.  After  a  destructive  fire,  the  insurance 
companies  compromised  with  him  for  the  sake  of  policy; 
but  when  there  are  large  amounts  involved  in  a  conflagra- 
tion, do  not  expect  the  underwriters  to  overlook  your  care- 
lessness. It  is  too  much  to  expect  of  human  nature.  The 
moral  is  to  buy  your  insurance  from  insurance  companies 
of  good  reputation,  and  to  place  it  with  agents  unques- 
tionably competent  to  advise  you.  Finally,  remember  that 
prevention  saves  loss. 


CHAPTER  XIV 

CORPORATIONS 

BY  JUDGE  FRANK  G.  FINLAYSON 

When  so  large  a  proportion  of  the  business  of  the 
country  is  carried  on  under  the  corporate  form,  it  is  abso- 
lutely essential  that  the  credit  man  have  at  least  a  gen- 
eral knowledge  of  the  organization  of  the  corporation, 
its  methods  of  acting  and  carrying  on  its  business,  and 
more  particularly  of  the  responsibilities  and  liabilities  of 
the  corporation  itself,  and  of  its  officers,  directors,  and 
stockholders.  For  this  reason  a  discussion  of  the  more 
important  points  of  corporate  organization  and  pro- 
cedure are  not  out  of  place  in  the  present  volume. 

Nature  of  the  Corporation 

A  corporation  may  be  defined  as  an  entity,  created 
and  recognized  by  law,  and  endowed  with  certain  attri- 
butes usually  inherent  in  an  individual;  as,  for  example, 
the  power  to  conduct  business,  the  right  to  commence  and 
defend  actions  in  law,  and,  most  important  of  all,  the 
right  to  maintain  a  continuous  existence  notwithstanding 
constant  changes  in  its  officers  and  membership.  These, 
briefly,  are  a  few  of  the  most  important  characteristics  of 
corporations. 

Classes  of  Corporations 

Corporations  are  either  public  or  private.  Public  cor- 
porations are  endowed  with  certain  governmental  powers 

265 


266  MERCANTILE  CREDITS 

which  they  exercise  in  certain  subdivisions  or  localities  of 
the  state,  as  cities,  towns,  school  districts,  and  irrigation 
districts.  All  corporations  not  classed  as  public,  are  pri- 
vate corporations.  Another  way  of  classing  corporations 
is  to  distinguish,  (i)  those  for  profit,  and  (2)  those  for 
some  purpose  other  than  profit. 

As  our  purpose  here  is  to  consider  only  private  cor- 
porations, or,  in  other  words,  business  corporations 
organized  for  profit,  we  shall  leave  out  of  the  question 
public  corporations,  and  corporations  not  organized  for 
profit,  such  as  religious,  eleemosynary,  educational  cor- 
porations, etc. 

Incorporation  Laws 

We  will  take  up  first  the  methods  of  incorporation. 
The  early  English  custom  was  to  create  each  corporation 
by  a  distinct  act  of  Parliament,  or  by  grant  of  the  Crown; 
and  such  act  or  grant  constituted  its  charter.  Today,  in 
practically  all  our  states  corporations  are  organized  under 
general  laws.  In  other  words,  there  is  no  special  legisla- 
tive act  creating  each,  but  a  general  law  under  which  any 
number  of  corporations  may  be  organized. 

Capital  Stock 

Let  us  say  a  word,  first,  about  capital  stock.  I  wish 
to  emphasize  particularly  the  distinction  between  the  capi- 
tal of  a  corporation — capital  such  as  any  individual  may 
own — and  its  capital  stock.  Capital,  as  distinguished  from 
capital  stock,  or  share  capital,  consists  of  the  property 
owned  by  the  corporation,  without  regard  to  whether  it 
was  contributed  by  the  stockholders  or  not.  The  capital 
stock  of  a  corporation,  on  the  other  hand,  is  that  sum 
mentioned  in  the  articles  of  incorporation  as  the  sum  for 
which  the  company  is  capitalized,  and  such  sum  may  have 


CORPORATIONS  267 

either  a  potential  or  an  actual  existence.  For  example, 
when  the  company  is  organized,  and  before  any  stock  is 
subscribed  for,  the  capital  stock  has  a  potential  existence 
only;  but  when  there  are  subscribers  for  the  shares  of  that 
company,  the  capital  stock  has  an  actual  existence, 
whether  the  money  is  paid  in  or  not,  for  the  reason  that 
those  who  subscribe  for  the  stock  become  indebted  to  the 
corporation  to  the  extent  of  their  subscriptions.  For 
example,  suppose  a  corporation  is  capitalized  for  $100,- 
ooo,  divided  into  one  dollar  shares,  and  that  all  the  stock 
is  subscribed,  but  none  is  paid.  There  is,  in  such  case, 
$100,000  due  the  corporation  that  can  be  collected — 
$100,000  of  debts — and  if  they  are  good,  collectable 
debts,  it  has  assets  of  $100,000. 

Rights  of  Stockholders 

We  will  consider  now  the  relation  of  the  stockholders 
to  the  corporation.  The  stockholders  have  no  direct 
ownership  in  any  of  the  property  of  the  corporation. 
They  simply  own  the  shares;  and  these  shares  are  per- 
sonal property,  even  though  the  corporation  may  have 
nothing  but  real  property.  To  illustrate;  let  us  suppose 
that  ten  men  own  a  lot  in  this  city  worth  $10,000.  Each 
of  the  ten  men  owns  an  equal  share,  the  value  of  which  is 
$  1,000.  Unless  all  agree  to  sell,  the  land  cannot  be  sold; 
none  of  them  can  be  forced  to  sell.  Of  course,  each  one 
could  sell  his  individual  interest,  but  the  land  itself  could 
not  be  sold  unless  all  agreed. 

Now,  let  us  suppose  that  those  ten  men  organize  a 
corporation,  capitalized,  we  will  say,  for  $10,000.  They 
convey  the  land  to  the  corporation,  and  issue  to  them- 
selves all  the  stock  of  the  corporation,  each  taking  one- 
tenth,  and  they  elect  a  board  of  directors.  Those  owning 
a  majority  of  the  stock  will  control  a  majority  of  the 


268  MERCANTILE  CREDITS 

board.  They  elect,  say,  three  directors  to  manage  the 
corporation,  and  these  directors  think  it  best  to  sell  the 
land  and  buy  other  property  with  the  proceeds.  They 
may  do  so  without  securing  the  consent  of  each  of  the  ten 
stockholders.  One  individual  stockholder  may  strongly 
object  to  this  sale;  but  he  cannot  help  himself.  The 
others  can  sell  it — the  corporation,  rather,  can  sell  it — 
because  the  stockholder  no  longer  owns  any  interest  in  the 
land  itself,  but  simply  an  interest  in  the  corporation.  The 
property  owned  by  the  corporation  is  real  property;  but 
the  shares  of  stock  are  regarded  as  personal  property. 

What,  then,  is  the  interest  of  the  shareholder  in  a 
corporation?  First,  the  right  to  receive  his  proportion  of 
such  dividends  as  may  be  paid  by  the  corporation;  and, 
second,  the  right  to  receive  his  proportion  of  such  assets 
of  the  corporation  as  may  remain  upon  its  dissolution, 
after  all  creditors  have  been  paid,  these  assets  being  dis- 
tributed among  the  shareholders  in  proportion  to  their 
respective  holdings.  These  are  the  only  rights  the  share- 
holder has,  except  those  relative  to  the  organization  of  the 
corporation. 

Subscribing  for  Stock 

How  does  one  become  a  shareholder?  By  subscrib- 
ing for  stock.  It  should  be  noted  that  the  word  subscrip- 
tion has  a  meaning  in  this  connection  broader  than  its 
usual  significance.  A  man  subscribes  for  stock  when  he 
agrees  to  take  stock,  whether  in  writing  or  otherwise.  He 
need  not  sign  his  name  to  any  document  in  order  to  be- 
come a  subscriber,  subject  to  all  the  liabilities  and  entitled 
to  all  the  rights  of  a  subscriber.  The  word  subscription 
is  generally  used,  however,  because  one  of  the  most  com- 
mon methods  of  subscribing  for  stock  is  to  sign  a  paper  in 
which  each  person  subscribes  for  the  number  of  shares 


CORPORATIONS  269 

set  opposite  his  name.  But  a  man  subscribes  for  stock 
when,  by  any  contract,  oral  or  written,  he  agrees  to  take 
any  of  the  shares  of  stock;  and  he  thereupon  becomes 
liable  for  the  payment  of  those  shares.  It  is  not  neces- 
sary that  a  certificate  of  stock  should  issue.  If  I  say  to 
the  secretary  of  a  corporation,  "I  will  take  ten  shares  of 
stock  in  your  corporation,"  and,  if  the  secretary  has 
authority  to  sell,  and  accepts  my  offer  to  purchase,  I  be- 
come liable  as  a  shareholder  then  and  there;  and  the 
secretary,  on  the  other  hand,  has  made  a  binding  agree- 
ment to  sell  it  to  me,  though  the  certificate  may  not  be 
issued  to  me  for  years  afterward. 

The  law  provides  that  a  certificate  must  be  issued 
when  the  stock  is  paid  in  full,  though  not  necessarily  be- 
fore; in  case  it  is  issued  before  payment  in  full,  it  must, 
in  California,  declare  that  fact  on  its  face.  A  certificate 
is  simply  a  muniment  of  title.  It  evidences  the  fact  that 
the  man  whose  name  appears  thereon  is  the  owner  of  the 
number  of  shares  mentioned  therein.  But  he  is  a  share- 
holder whether  he  receives  the  certificate  or  not. 

Stock  Transfers 

Having  explained  how  an  individual  becomes  a  share- 
holder, the  next  question  is,  How  may  he  transfer  his 
stock?  A  shareholder  may  transfer  his  stock  to  another 
by  any  agreement  to  transfer;  and,  as  between  the  parties 
to  the  agreement,  the  transfer  is  full  and  complete  when 
the  agreement  is  made.  The  ordinary  method  is  for  the 
holder  of  the  stock — the  transferer — to  indorse  his  name 
on  the  back  of  the  certificate,  if  he  has  one,  and  deliver  it 
to  the  transferee,  whereupon  the  latter  becomes  the 
owner  of  the  stock,  as  between  himself  and  the  original 
owner,  but  not  as  between  himself  and  the  corporation. 
The  corporation  will  still  regard  the  person  to  whom  it 


270  MERCANTILE  CREDITS 

sold  the  stock  as  the  owner  of  the  stock,  because  his  name 
still  appears  on  the  books  as  the  owner  thereof.  In  other 
words,  as  to  the  corporation  the  transfer  of  the  stock  is 
not  completed  until  it  has  been  entered  on  the  books  of 
the  corporation. 

To  complete  the  transfer  the  transferee  must  go  to  the 
secretary  of  the  corporation,  present  the  stock  certificate, 
and  request  the  proper  transfer  of  the  stock  it  represents. 
If  the  secretary  objects,  he  should  make  a  formal  demand 
which  might  be  as  follows :  "Here  is  this  stock  certificate 
indorsed  on  the  back,  and  delivered  to  me  by  the  former 
owner  thereof.  I  demand  that  you  note,  in  your  stock 
and  transfer  book,  the  fact  that  these  shares  have  been 
transferred  to  me."  He  may  also  demand  the  reissue  of 
the  stock  in  his  own  name.  If  the  secretary  refuses  to 
make  the  transfer  on  the  books  of  the  corporation,  the 
holder  of  the  certificate  may  bring  a  proper  action  in  court 
to  compel  him  to  do  so,  and  may  hold  the  secretary  liable 
for  damages  if  he  has  wilfully  neglected  to  comply  with 
the  demand. 

If  no  stock  certificates  have  been  issued,  A,  the  origi- 
nal holder  of  the  stock,  may  make  a  bill  of  sale  to  B,  and 
thus  make  B  the  owner  of  the  stock.  That  is,  you  under- 
stand, the  owner  as  between  these  two,  but  not  as  between 
either  one  of  them  and  the  corporation.  As  between  them 
and  the  corporation,  A  remains  the  owner  until  the  trans- 
fer is  entered  on  the  books  of  the  corporation. 

Organizing  the  Corporation 

Let  us  now  consider  for  a  moment  the  organization  of 
the  corporation  and  the  powers  of  its  officers.  In  Cali- 
fornia and  in  most  of  the  other  states  where  general  laws 
exist  under  which  companies  are  incorporated,  a  number 
of  men  entitled  to  incorporate  a  company — three  or  more 


CORPORATIONS  271 

in  California — sign  their  names  to  articles  of  incorpora- 
tion which  set  forth  among  other  things :  the  name  of  the 
proposed  corporation,  the  amount  of  its  capital  stock,  the 
number  of  shares  into  which  it  is  divided,  the  par  value 
of  the  stock,  the  directors  for  the  first  year,  and  the  pur- 
poses for  which  the  company  is  incorporated.  The  sub- 
scribers to  the  articles  must  go  before  a  notary  and 
acknowledge  their  subscriptions  to  the  articles  of  incor- 
poration, or  acknowledge  the  fact  that  they  have  sub- 
scribed to  the  articles.  The  articles  are  then  filed  in  the 
office  of  the  county  clerk,  and  a  certified  copy  is  trans- 
mitted to  Sacramento,  to  be  filed  in  the  office  of  the  Secre- 
tary of  State,  who,  if  the  articles  of  incorporation  are  in 
accordance  with  the  requirements  of  the  statutes,  files 
them  and  issues  a  certificate  of  incorporation.  The 
articles  of  incorporation  after  filing  become  the  charter  of 
the  corporation. 

The  next  thing,  after  the  company  has  thus  come  into 
existence,  is  to  organize.  Usually  the  stockholders  meet 
at  a  certain  time  and  place,  agree  on  the  by-laws,  and  sign 
them.  The  directors,  who  are  usually  named  in  the 
articles  themselves,  meet  immediately  after  the  adjourn- 
ment of  the  stockholders.  At  this  meeting  some  one  is 
elected  to  preside,  and  then  the  board  is  organized  by 
electing  the  officers  of  the  company — the  president,  the 
vice-president,  the  secretary,  treasurer,  etc. 

Powers  of  the  Directors 

Let  us  consider  for  a  moment  the  powers  of  the  direc- 
tors. The  board  of  directors  (a  distinction  must  be  drawn 
between  the  directors  as  individuals,  and  the  directors  act- 
ing as  a  board)  has  sole  charge  of  the  business  of  the 
corporation  and  the  control  of  its  property.  In  other 
words,  the  management  of  the  corporation  is  vested  in  the 


272  MERCANTILE  CREDITS 

board  of  directors,  which  is  intrusted  with  all  discre- 
tionary powers.  Ministerial  powers  and  duties  may  be 
delegated,  but  discretionary  powers  such  as  possessed  by 
the  directors  may  not.  It  is  a  rule  of  agency  that  an 
agent  in  whom  there  has  been  vested  a  discretion  may 
not  re-delegate  his  discretionary  power. 

Corporations,  however,  must  be  conducted  by  officers, 
and  the  board  may  confer  administrative  powers  upon 
employees  and  agents.  Let  us  say  that  a  corporation 
owns  a  piece  of  land,  and  the  question  of  its  sale  is  under 
consideration.  No  officer  of  the  corporation  has  the  right 
to  say  whether  or  not  that  land  shall  be  sold ;  that  must  be 
determined  by  the  board  of  directors,  which  cannot  dele- 
gate this  right  to  the  president  or  any  other  officer. 

We  will  assume,  therefore,  that  the  board  meets  as  a 
board,  passes  a  resolution  to  sell  the  land,  and  also  re- 
solves that  the  deed  shall  be  signed  for  the  corporation 
and  in  its  name  by  the  president  and  secretary.  Under 
that  resolution  the  president  and  secretary  sign  the  deed 
for  and  in  the  name  of  the  corporation.  In  this  case  the 
discretionary  power  of  determining  whether  the  land  shall 
be  sold  is  exercised  by  the  board  of  directors ;  but  the  mere 
administrative  act  of  signing  the  deed  has  been  delegated 
to  the  president  and  secretary.  This  example  illustrates 
the  difference  between  the  discretionary  powers  which 
are  vested  wholly  in  the  board  of  directors  and  cannot  be 
delegated,  and  the  administrative  powers  which  may  be 
delegated. 

Nor  can  directors,  except  at  a  lawful  meeting  and  as 
a  board,  transact  any  business  on  behalf  of  the  corpora- 
tion, or  bind  the  corporation  by  their  acts,  although,  under 
certain  circumstances,  the  corporation  may  be  estopped 
from  questioning  the  assumed  authority  of  the  directors 
acting  individually,  Other  cases  of  individual  represen- 


CORPORATIONS  273 

tation  may  arise.  A  director,  for  example,  while  per- 
forming some  duty  on  behalf  of  the  corporation  might 
receive  notice  of  some  fact  and  this  notice  might  consti- 
tute notice  to  the  corporation.  But  no  one  director,  nor 
any  number  of  them,  can,  as  directors,  act  authoritatively 
on  behalf  of  the  corporation,  except  when  sitting  as  a 
board  of  directors.  This  is  a  very  important  thing  to 
bear  in  mind.  Secretaries  of  corporations  sometimes  go 
among  the  absent  directors,  and  ask  them  to  sign  their 
names  to  an  agreement  relating  to  something  that  a 
minority  of  the  board  has  done,  or  attempted  to  do,  at  a 
board  meeting,  there  not  being  a  quorum  present.  Sup- 
pose five  directors  constitute  a  quorum.  Three  meet  and 
attempt  to  transact  business,  knowing,  of  course,  that  they 
cannot  legally  do  it.  After  the  so-called  board  meeting 
has  adjourned,  the  secretary  goes  around  and  gets  the 
other  directors  to  agree  to  what  has  been  done.  He 
might  as  well  ask  the  policeman  on  the  corner  to  agree 
to  it,  for  all  the  legal  effect  the  signature  would  have. 
Only  when  meeting  as  a  board  with  a  quorum  present  can 
the  directors  act  on  behalf  of  the  corporation. 

Powers  of  the  Officers 

Let  us  now  consider  the  powers  which  are  vested  in 
the  officers  of  a  corporation.  It  is  frequently  thought 
that  the  president  of  a  corporation  has  very  extensive 
powers,  but  this  is  not  necessarily  so.  He  has  only  such 
powers  as  are  vested  in  him  by  the  board  of  directors.  Of 
course,  he  may  have  ostensible  powers  greater  than  the 
powers  that  have  been  expressly  delegated  to  him.  The 
corporation  may  allow  him  to  continue  a  certain  line  of 
action,  or  may  know  that  he  is  making  certain  contracts, 
assuming  the  authority  to  do  so ;  they  may  allow  others  to 
deal  with  him,  who  suppose  that  he  has  this  power.  In 


274  MERCANTILE  CREDITS 

such  cases,  the  corporation  would  be  estopped  from  plead- 
ing his  lack  of  power.  But  he  actually  has  only  such 
authority  as  the  board  expressly  delegates  to  him. 

The  General  Manager 

An  officer  usually  vested  with  great  power  is  the  gen- 
eral manager.  As  the  title  implies,  he  has  the  general 
management  of  the  business  of  the  corporation,  and  may 
make  any  contract  or  perform  any  act  on  behalf  of  the 
corporation,  provided  it  be  within  the  company's  general 
line  of  business.  This,  of  course,  does  not  include  the 
exercise  of  certain  discretionary  powers,  as  in  regard  to 
the  sale  of  land,  but  even  in  such  a  case  the  board  might 
delegate  to  him  the  power  to  sell  the  land  under  certain 
conditions,  leaving  him  to  decide  when  the  conditions  exist. 

The  Cashier 

Another  officer  with  considerable  power  is  the  cashier 
of  a  bank.  Custom  has  intrusted  him  with  the  per- 
formance of  certain  duties,  and  the  courts  assume,  there- 
fore, that  certain  acts,  when  performed  by  the  cashier  of 
a  bank,  are  authorized  by  his  superiors.  The  mere  title 
of  cashier  implies  that  certain  things  may  and  will  be  done 
by  him.  We  have  here  another  application  of  the  doctrine 
of  agency  relative  to  ostensible  authority;  and  where 
such  authority  is  apparent  to  the  world,  the  principal  is 
estopped  from  denying  that  it  exists.  When  the  directors 
of  a  bank  appoint  a  cashier,  the  public  takes  it  for  granted 
that  they  have  turned  over  to  him  certain  functions. 

Directors  Trustees  for  the  Stockholders 

Now,  a  word  or  two  upon  the  relation  of  the  directors 
to  the  stockholders,  to  the  corporation  itself,  and  to  the 
creditors.  The  directors  are  trustees  for  the  stockholders, 


CORPORATIONS  275 

and  are  therefore  held  to  the  exercise  of  the  highest 
fidelity — or,  to  use  the  Latin  expression,  uberrima  fides — 
in  all  dealings  involving  the  rights  of  stockholders.  On 
the  dissolution  of  a  corporation,  the  directors  become 
trustees  for  the  creditors  of  the  corporation — just  as  dur- 
ing its  existence  they  are  trustees  for  the  stockholders — 
with-  all  the  duties  and  obligations  that  trustees  generally 
owe  to  their  cestui  que  trust. 

No  Dividends  Can  be  Paid  Out  of  Capital 

Now,  as  to  the  inhibitions  which  the  statutory  law  in 
California  imposes  upon  directors  of  corporations  and 
which  are  much  the  same  in  the  other  states.  In  the  first 
place,  our  code  provides  that  the  directors  must  not  pay 
dividends  except  from  surplus  profits.  To  make  clear 
the  meaning  of  this,  let  us  suppose  that  a  corporation  is 
capitalized  for  $100,000.  All  of  its  stock  has  been  sub- 
scribed, and  50  per  cent  has  been  paid  up,  so  that  $50,000 
has  been  paid  to  the  corporation  by  the  holders  of  its 
shares  of  stock.  We  will  suppose  that  the  company  has 
loaned  this  $50,000,  at  6  per  cent,  and  has  made  $3,000 
at  the  end  of  the  first  year.  It  has  had  no  expenses,  has 
not  been  conducting  any  offices  or  paying  salaries,  so  that 
the  $3,000  is  a  net  profit,  and  dividends  may  be  paid  out 
of  that  $3,000,  and  distributed  to  the  shareholders.  But 
no  part  of  the  $50,000  paid  in  by  them  can  be  distributed 
in  dividends;  and,  if  the  directors  do  this,  they  are  guilty 
of  a  misdemeanor,  for  which  they  may  be  severely 
punished. 

Limitation  of  Indebtedness 

Another  inhibition  peculiar  to  California  is  this: 
Directors  must  not  create  any  debts  beyond  the  amount  of 
the  subscription  of  the  capital  stock.  Let  us  say  a  com- 


276  MERCANTILE  CREDITS 

pany  is  capitalized  for  $100,000.  Half  of  its  stock  has 
been  issued.  The  amount  subscribed  is  $50,000.  It 
may  create  debts  up  to  $50,000.  Beyond  that  the  direc- 
tors may  not  go.  If  they  do,  they  are  personally  liable 
for  the  debts. 

Capital  Must  Not  be  Divided  Before  Dissolution 

A  third  inhibition  is  this:  The  directors  must  not  pay 
dividends  out  of  any  part  of  the  capital  stock,  nor  with- 
draw any  part  of  it,  nor  divide  any  part  of  it  except  on 
dissolution.  In  other  words,  in  the  case  I  have  just  sup- 
posed, where  $50,000  has  been  paid  in,  the  company  be- 
ing capitalized  for  $100,000,  no  part  of  that  $50,000  can 
be  divided  among  the  stockholders  until  the  day  of  dissolu- 
tion. Then,  if  there  is  anything  remaining  after  the  credi- 
tors have  been  paid,  the  $50,000  or  what  is  left  of  it  may 
be  divided  among  the  shareholders. 

Contracts  with  Directors 

I  said  a  moment  ago  that  the  directors  of  a  corpora- 
tion are  trustees  for  the  stockholders,  and  are  therefore 
held  to  the  utmost  good  faith.  One  of  the  results  of  that 
doctrine  is  that  a  director  may  not  make  a  contract  with 
himself.  If  he  does,  it  is  voidable  at  the  instance  of  the 
corporation,  or  of  any  of  the  stockholders  suing  in  behalf 
of  the  corporation.  Some  of  the  courts  have  held  that 
the  contract  is  absolutely  void;  others  hold  that  it  is  void- 
able, but  that  it  will  be  upheld  if  the  contract  be  fair  and 
if  the  director  has  agreed  to  part  with  a  fair  considera- 
tion. The  middle  ground  is  that  it  is  not  absolutely  void, 
but  voidable  at  the  instance  of  the  corporation,  or  of  any 
stockholder  who  may  bring  suit  on  behalf  of  the  corpora- 
tion, and  that  the  corporation  may  void  the  contract  or 
regard  it  as  voidable,  whether  it  be  a  fair  contract  or  not 


CORPORATIONS  277 

The  court  will  not  inquire  into  the  fairness  of  the  contract 
It  will  say  to  the  director,  "You  must  not  deal  with  the 
corporation  for  your  own  benefit." 

Nor  can  a  director  who  is  personally  interested  in  a 
contract  in  which  the  corporation  also  is  interested,  make 
up  a  quorum  at  a  directors'  meeting.  That  is,  suppose 
that  there  are  five  directors  and  three  constitute  a  quorum. 
One  of  the  directors  wishes  to  make  a  contract  with  the 
corporation.  He  can  make  that  contract;  but  he  cannot, 
as  a  director  of  the  corporation,  take  part  in  the  making 
of  it.  If  three  directors  meet,  of  whom  he  is  one,  there 
is  no  quorum  for  the  purpose  of  making  such  a  contract. 
There  are  only  two  directors  present.  To  make  a 
quorum,  another  director,  not  interested  in  the  contract, 
must  be  present.  In  other  words,  where  there  are  five 
directors  in  a  corporation,  and  three  make  a  quorum, 
there  must  be  present  three  who  have  no  personal  inter- 
est, direct  or  indirect,  in  the  proposed  contract. 

Dummy  Directors 

Let  me  say  a  word  here  as  to  <rdummy"  directors. 
Dummy  directors  are  not  recognized  by  the  law.  Re- 
cently a  case  came  before  a  New  York  court,  the  facts  of 
which  were  somewhat  as  follows :  Two  men  were  in  part- 
nership, running  a  certain  business,  and  they  agreed  to 
convey  all  of  the  partnership  assets  to  a  corporation  to 
be  organized,  and  to  divide  the  shares  equally  between 
them,  except  a  few  that  they  reserved  for  the  purpose  of 
qualifying  certain  directors.  In  other  words,  because  the 
law  provided  that  there  must  be  more  than  two  directors, 
the  original  two  agreed  to  issue  to  other  persons  certain 
shares  of  stock  in  order  to  qualify  them  for  directors. 
But  they  agreed  that  these  other  directors  should  not 
exercise  any  authority,  but  do  what  they  were  told  to  do — 


278  MERCANTILE  CREDITS 

in  other  words,  should  be  dummy  directors.  It  was 
further  agreed  that  the  business,  when  transferred  to  the 
corporation,  should  continue  as  before,  and  that  the  two 
original  partners  should  have  equal  authority.  One  of 
the  two,  however,  broke  his  contract,  and  influenced  some 
of  the  directors  to  act  with  him  in  conducting  the  business 
in  a  way  contrary  to  the  contract  made  before  the  organi- 
zation of  the  corporation.  The  other  partner  then  asked 
to  have  a  receiver  appointed  by  the  courts.  It  was  held 
that  the  contract  was  illegal  in  so  far  as  it  provided  for 
dummy  directors,  that  it  could  not  be  enforced,  and  that 
no  receiver  would  be  appointed.  The  court  said  in  sub- 
stance that  every  director  of  that  corporation  must  exer- 
cise his  judgment  for  and  on  behalf  of  the  corporation 
and  that  it  was  a  fraud  upon  the  law  that  directors  should 
simply  be  dummies.  If  these  directors  ceased  to  be 
marionettes,  and  woke  up  and  became  flesh  and  blood  in- 
dividuals, they  were  doing  what  they  had  the  right  to  do, 
and  what  it  was  their  legal  duty  to  do. 

Promoters 

A  promoter  is  one  who  takes  upon  himself  the 
organization  of  a  corporation — the  task  of  bringing  it 
into  being.  He  is  not  an  agent  of  the  corporation,  at  least 
not  before  it  conies  into  existence.  Then,  and  not  until 
then,  may  the  corporation,  through  its  board  of  directors, 
vest  certain  powers  in  the  promoter.  Of  course,  these 
promoters  may  continue  to  care  for  the  destinies  of  the 
corporation  which  they  have  created,  but,  when  they  do 
that,  they  are  not  acting  as  promoters.  Strictly  speaking, 
a  promoter  acts  only  up  to  the  time  that  the  corporation 
is  launched. 

Next,  let  us  consider  the  relations  of  the  promoters 
inter  se.  They  are  trustees  as  among  themselves,  as  they 


CORPORATIONS  279 

are  for  the  future  stockholders.  As  among  themselves, 
their  relationship  is  somewhat  analogous  to  that  of  co- 
partners; and,  unknown  to  the  others,  one  cannot  enter 
into  any  arrangement  that  would  redound  to  his  special 
benefit.  He  must  act  with  that  same  good  faith  that  one 
partner  exercises  on  behalf  of  his  copartners.  If  he 
makes  any  arrangement  beneficial  to  himself,  he  must  tell 
his  fellow  promoters  about  it,  and  let  them  in  on  the  deal. 
Whatever  profit  he  makes  he  must  account  for,  both  to  his 
fellow  promoters  and  to  the  future  stockholders.  A  pro- 
moter cannot  make  a  profit  for  himself  unless  it  is  known 
to  those  who  may  become  stockholders.  In  other  words, 
if  a  promoter  has  made  a  profit  for  himself,  it  is  his  duty 
when  he  launches  the  company  to  see  that  there  is  elected 
an  independent  board  of  directors — one  that  does  not  con- 
trol— and  then  he  must  inform  this  board  of  his  dealings 
in  order  that  that  board  of  directors,  which  represents  the 
stockholders,  may  know  exactly  what  profit  he  has  made. 

I  say  he  must  bring  into  being  an  independent  board 
of  directors.  Now,  it  may  be  that  the  promoters  are  all 
the  stockholders,  that  all  the  stock  is  issued  to  them- 
selves, and  that  there  are  no  creditors  of  the  corporation. 
In  a  case  of  that  kind,  the  promoter  may  make  as  much 
profit  as  he  pleases,  but  he  cannot  make  it  at  the  expense 
of  his  fellow  stockholders  unless  they  know  about  it,  be- 
cause each  is  a  trustee  to  the  other;  each  owes  the  utmost 
good  faith  to  all  the  others,  and  no  one  of  them  must 
make  any  secret  profits.  But  in  the  case  that  I  have  just 
cited,  since  there  are  no  other  present  stockholders,  he 
may  make  any  profit  possible  if  the  other  promoters 
agree  to  it. 

Promotion  Stock 

Now  as  to  the   compensation  of  promoters.     You 


MERCANTILE  CREDITS 

sometimes  hear  about  promotion  stock.  That  is  illegal. 
A  corporation  does  not  owe  anything  to  a  promoter  for 
bringing  it  into  being.  The  promoter  must  look  else- 
where for  his  compensation.  What  he  does  for  the  cor- 
poration after  it  has  been  brought  into  being  he  may  be 
paid  for;  but  the  corporation  owes  him  nothing  for  his 
services  prior  thereto.  The  promoters  get  around  that  in 
various  ways.  One  method  is  for  the  promoter  to  trans- 
fer property  to  the  corporation  at  an  inflated  valuation 
and  get  stock  for  it;  but  that  is  a  fraud  upon  the  law. 

Watered  Stock 

"Watered  stock"  is  stock  which  has  a  fictitious  valua- 
tion. Let  me  illustrate.  We  will  say  that  ten  men 
organize  a  corporation.  These  ten  men  have  a  lot  in  this 
city  worth  $10,000,  and  they  capitalize  for  $100,000. 
They  transfer  their  $10,000  lot  to  the  corporation  for  all 
the  shares  of  the  corporation,  and  cause  the  board  to 
adopt  a  resolution  something  like  this:  "Whereas  John 
Doe,  Richard  Roe,  etc.  (naming  the  ten  men)  have 
offered  to  sell  to  this  corporation  a  certain  lot  (describing 
it),  valued  at  $100,000,  for  $100,000  worth  of  stock; 
now  therefore,  be  it  resolved,  that  their  proposition  be 
accepted,  and  the  president  and  secretary  be  authorized 
to  accept  said  property  from  the  said  parties  and  issue 
said  $100,000  of  stock  to  them."  The  result  is  that  the 
corporation  has  a  piece  of  land  worth  but  $10,000,  and 
the  shareholders  have  all  the  stock,  which  is  nominally 
worth  $100,000,  but  in  reality  is  only  worth  $10,000 — 
the  value  of  the  land.  The  stock  has  been  watered,  it 
has  a  fictitious  valuation,  and  the  subsequent  creditors  of 
the  corporation  may  suffer  on  account  of  it,  because  they 
may  give  credit  to  that  corporation  on  the  assumption 
that  it  has  property  behind  the  stock  really  worth 
$100,000. 


CORPORATIONS  281 

StockM  ust  be  Issued  for  Value  Only 

In  most  of  the  states,  it  is  provided  that  stock  shall  not 
issue  except  for  money  or  money's  worth.  That  is  not  the 
language  of  the  constitution,  or  the  language  of  the 
statute ;  but  it  is  quite  a  familiar  legal  phrase.  Directors 
may  not  agree  to  issue  stock  for  money  unless  they  agree 
that  it  shall  be  issued  for  the  full  par  value  of  the  stock. 
Nor  can  they  legally  agree  to  issue  stock  for  property 
unless  it  is  issued  for  property  worth  the  face  value  of 
the  stock. 

Now,  that  latter  mode  of  procedure,  namely,  issuing 
stock  for  property,  has  given  rise  to  two  doctrines.  In 
some  states  it  is  held  that  a  transaction  is  voidable  at  the 
instance  of  the  corporation  or  of  its  creditors — particu- 
larly of  creditors — unless  the  stock  be  issued  for  property 
the  value  of  which  is  fairly  equal  to  the  nominal  or  par 
value  of  the  stock.  This  is  known  as  the  "fair  valuation'* 
doctrine. 

In  other  states  it  is  held  that,  even  though  the  prop- 
erty be  not  fairly  equal  to  the  par  value  of  the  stock 
issued  for  it,  nevertheless,  if  the  directors  have  acted  in 
good  faith,  the  transaction  will  stand,  even  as  against  the 
attack  of  creditors,  and  it  is  a  valid  issue  of  stock  for  the 
property.  But  even  in  these  cases  the  courts  hold  that  if 
there  is  great  and  glaring  disparity  between  the  par  value 
of  the  stock  that  is  issued  for  the  property  and  the  value 
of  the  property  itself,  that  disparity  of  values  is,  of  itself, 
a  badge  of  fraud;  and,  at  the  suit  of  a  creditor,  the  trans- 
action may  be  set  aside,  or  the  stockholders  be  compelled 
to  pay  into  the  corporation  for  the  benefit  of  the  creditors 
the  difference  between  the  fair  value  of  the  property  and 
the  value  of  the  stock  issued  for  it.  That  is  known  as  the 
"good  faith"  doctrine,  and  it  acts  as  a  wholesome  restraint 
on  undue  inflation  of  values. 


282  MERCANTILE  CREDITS 

Face  Value  of  Stock  Not  Always  the  Actual  Value 

Notwithstanding  the  fact  that  our  law  and  our  con- 
stitution provide,  in  effect,  that  no  stock  shall  issue  except 
for  money  or  money's  worth,  our  supreme  court  has  held 
that  if  a  corporation  has  no  creditors,  and  all  of  the  stock 
is  to  be  issued  to  the  organizers,  they  may  transfer  prop- 
erty to  the  corporation  worth  very  much  less  than  the  par 
value  of  the  stock  issued  to  them  for  their  property.  The 
courts  say  that  in  that  case  no  one  is  defrauded;  for  there 
are  no  creditors,  and  there  are  to  be  no  future  stock- 
holders ;  and,  all  the  existing  stockholders  having  agreed, 
the  transaction  will  stand,  even  though  $100,000  worth  of 
stock  be  issued  for  property  worth  only  $10,000.  If  the 
transaction  appears  on  the  books  of  the  corporation,  as 
it  should,  the  future  creditors  can  go  to  the  books  of  the 
corporation  and  see  that  all  the  property  it  owns,  in  the 
case  I  have  assumed,  is  a  lot  worth  $10,000,  and  not  assets 
worth  $100,000. 

The  Stockholder's  Liability 

A  stockholder's  liability  to  creditors  of  his  corpora- 
tion is  of  two  kinds :  first,  what  is  known  as  the  equitable 
liability,  and,  second,  the  statutory  liability. 

Consider  first  the  equitable  liability.  That  arises  out 
of  the  "trust  fund"  theory.  By  this  theory,  when  a  stock- 
holder subscribes  for  stock,  he  agrees,  expressly  or  by 
implication,  to  pay  to  the  corporation  the  full  par  value 
of  the  stock  whenever  called  upon  by  the  directors.  If  he 
does  not  pay  it  all,  he  is  liable  for  the  unpaid  balance. 
The  directors  may  never  call  it  in,  for  they  may  not  need 
the  money;  but  in  California  they  may  do  so  if  they  wish; 
and  they  should  exercise  their  authority  to  do  so  whenever 
necessary  to  pay  the  creditors  of  the  corporation.  This 
sum  which  the  stockholders  are  thus  liable  to  be  called 


CORPORATIONS  283 

upon  to  pay  at  any  time,  is  regarded  as  a  trust  fund  for 
the  benefit  of  the  creditors  of  the  corporation. 

Let  us  assume,  for  example,  that  a  corporation  is  in- 
corporated for  $100,000.  It  has  issued  all  of  its  stock, 
and  50  per  cent  of  the  par  value  has  been  paid  in.  Un- 
fortunate investments  have  been  made  with  this  $50,000, 
and  it  has  been  dissipated  and  lost.  There  is  still  $50,000 
due  from  the  stockholders,  which  may  be  called  in  by  the 
directors  at  any  time.  Let  us  assume  that  they  refuse  to 
call  it  in.  The  creditors  of  that  company  having  reduced 
their  claims  to  judgment,  can  then  go  into  a  court  of 
equity,  which  will  decree  that  the  defendants,  who  are  the 
stockholders  of  the  company,  shall  pay  the  remaining 
$50,000 — that  is,  each  shall  pay  his  pro  rata  thereof,  or 
so  much  thereof  as  may  be  necessary  to  satisfy  the  claims 
of  the  plaintiffs,  the  judgment  creditors.  That  is  the  trust 
fund  doctrine.  It  has  grown  out  of  certain  equitable  con- 
siderations, and  is  enforced  only  by  courts  of  equity. 

But  in  this  state,  and  one  or  two  other  states,  there  is 
what  is  known  as  the  statutory  stockholders'  liability, 
which  differs  from  the  trust  fund  theory.  The  statutory 
stockholders'  liability  is  this:  Each  stockholder  is  liable 
for  his  proportion  of  the  debts  created  while  he  is  a  stock- 
holder, and  his  proportion  is  such  proportion  of  the  debts 
as  the  stock  held  or  owned  by  him  bears  to  the  total 
amount  of  stock  subscribed.  Suppose  a  corporation  is  in- 
corporated for  $100,000.  This  is  divided  into  100,000 
shares  of  the  par  value  of  one  dollar  a  share.  Say  50,000 
shares  have  been  subscribed.  John  Doe  has  subscribed 
for  10,000  shares,  which  is  just  one-fifth  of  the  50,000. 
He  therefore  is  liable  for  one-fifth  of  the  debts  of  the  cor- 
poration created  while  he  is  a  stockholder,  but  he  cannot 
be  held  liable  for  any  part  of  the  debts  created  before  he 
was  a  stockholder. 


284  MERCANTILE  CREDITS 

Limitations  of  Stockholders'  Liability 

I  will  also  say  here  that  the  stockholders'  statutory 
liability  is  not  a  secondary  liability;  it  is  primary.  It 
arises  at  the  very  moment  that  the  liability  of  the  corpora- 
tion arises.  It  is  created  at  the  same  time,  and  is  barred 
by  the  statute  of  limitations  at  the  expiration  of  three 
years — a  provision  that  frequently  leads  to  very  anoma- 
lous results.  Let  us  suppose  that  a  corporation  lays  in  a 
large  supply  of  coal,  and  agrees  to  pay  $1,000  for  it.  It 
does  not  pay  it  at  once ;  the  debt  runs  on  for  a  year.  At 
the  end  of  the  year  the  corporation  cannot  pay,  but  agrees 
with  the  creditor  to  give  its  note  for  $1,000,  due  in  three 
years.  These  three  years,  plus  the  one  year  which  expired 
before  the  note  was  given,  make  four  years  from  the  time 
of  the  creation  of  the  obligation  by  the  purchaser  of  the 
coal  up  to  the  time  the  money  must  be  paid.  Now,  the 
claim  on  that  note  is  not  barred  by  the  statute  of  limita- 
tions until  four  years  after  the  note  falls  due,  which  is 
eight  years  after  the  coal  was  sold.  Then,  and  not  until 
then,  can  the  corporation  successfully  plead  the  statute  of 
limitations,  but  the  stockholder  can  plead  the  statute  at  the 
end  of  three  years  from  the  day  when  the  coal  was  pur- 
chased, because  his  obligation  has  nothing  to  do  with  the 
promissory  note  or  with  the  corporation's  liability  on  the 
debt.  His  is  an  independent,  primary  liability. 


INDEX 


Ability,  basis  of  credit,  75,  89,  90 
Accountant,  responsibility  as  to 

financial  statements,  124 
Accounts,  36-49,  102-117 

on     debtor's     books,     121-127, 

207 
Adjustment    Bureaus,    197,    199, 

233 

Agencies,  collection,  115 

mercantile,   17,  23,  65,  73,  87- 

101,  118 
rates,  101 

reports,  17,  23,  73,  91-101,  118 
Applicants  for  Credit,  ability,  75, 

89,  90 

assets,  76-78 

books  and  accounts,  76,  121 
character,  16,  25,  33,  59,  74,  82, 

89,90 
financial     statements,    21,    25, 

27-31,  64-86,  118-135,  190 
insurance,  80 
personal  status,  79 
Assets,  distribution  of,  236 
inflated,  126 
insurance  as,  80 
quick,  56,  77 
shrinkage  of,  126,  207 
Assignment,  of  claims,  143 

of  debtor's  business,  205,  212- 

214,  216,  230 

Attachments,  167,  168,  215 
Attorneys,  of  insolvent  debtors, 
200 

B 

Bad  Debts,  45 
Bank,  credits,  50-64 
references,  30,  133 
Bankers'  Liens,  153 
Bankruptcy,    215-217,    221,    223- 

245 

"acts  of,"  227 
composition  in,  232 
concealment  of  property,  241 
contempt  of  court,  242 
corporations  and,  225 


285 


discharge,  239-243 

examinations,  226,  231 

exemptions,  226 

false  statements,  241 

involuntary,  215-217,  225 

preferred  claims,  235-239 

reclamation  proceedings,  244 

referee  in,  234 

trustees,  229,  233,  234 

voluntary,  221,  225 
Boards  of  Trade,  California,  196, 
197,  233 

reports,  34,  120 

Bookkeeper's    Report,    on    cus- 
tomers, 38,  39 
Bookkeeping  Methods,  of  credit 

applicant,  76,  121 
Bottomry  Liens,  140 
Building  Associations,  128 


California,  boards  of  trade,  196, 

197,  233 

exemption   of  homestead,   168 
"false    statement    in    writing" 

law,  83,  119,  241 
Capital  Stock,  266-270,  279-282 
Character,  basis  of  credit,  16,  25, 

33,  59,  74,  82,  89,  90 
Claims,  assignment  of,  143 
preferred,  in  bankruptcy,  235- 

238 

Collateral,  60-63 
Collection  Agencies,  115 
Collections,  36-43,  104-117 
Composition      Settlement,     214, 

219,  232 
Concealment     of     Property,     in 

bankruptcy,  241 
Conditional  Sales,  115,  141,  154- 

157 
Contracts  of  Sale,  fraudulent,  157 

validity  of,  147 

Contracts  with  Directors,  276 
Corporations,    53-58,    68,    71-73, 

113,  225,  265-284 
applying  for  credit,  53-58 
close,  61 
directors,  54,  271-278 


286 


INDEX 


Corporations — Continued 

dividends,  275,  276 

four     classes     debarred    from 
bankruptcy,  225 

franchise  tax  on,  160 

indebtedness,  limitation  of,  275 

officers,  273,  274 

promoters,  278-280 

property  statement,  68,  7J-73 

stock  of,  266-270,  279-282 

stockholders,  267,  282-284 
Credit,     applicants     for.       (See 
"Applicants") 

associations,  27,  67-73,  J97>  229, 

233 

bank,  50-64 

bank  references,  30,  133 
character  as  factor,  16,  25,  33, 

59,  74,  82,  89,  90 
corporation   applying  for,   53- 

58 
department    methods,    14,    16, 

20-49 

forms.     (See  "Forms") 
fraudulent,  182 
information,  17,  22-39,  73,  64- 

TOI,  118-135 
insurance  of,  44,  261 
investigation,  20,  96,  103 
records,  34 

retail  man  applying  for,  58 
risks,   50,   73,   103 
Credit  Man,  duties  of,  8,  21,  104 
importance  of,  7,  21 
qualifications,  8,  16,  21,  32,  74 
personal  calls,  15,  33,  108 
sales  department  and,   16,  21, 

109 
Credit  Men,  cooperation  among, 

US 

Creditors,  196-245 

cooperation  of,  206,  221 

foreign,  214 

meetings,  199,  201-204,  212 

protection  of,  209 

responsibility     of,     in     bank- 
ruptcy, 235-238 
Customers.     (See  "Applicants") 

sharp  practices  of,  12,  17,  133- 

135 
wealthy,  112 


Debtors,  Insolvent,  196-222 
assignments,  205,  212-214,  216, 
230 


attachments,  215 
attorneys  of,  200 
bankruptcy,  217,  221,  223-245 
composition     settlement,    214, 

219 
consultation     with     creditors, 

199,  201-204,  212 
extension,    208-211,    219,    220, 

222 

fraudulent,  210,  216 

methods  of  settlement,  202 

protecting,  203,  209 

release,  216 

sale  of  business,  205 
Deeds,  in  escrow,  171 

trust,  170,  174-176 
Deficiency  Judgments,  173 
Destruction  of  Records,  by  bank- 
rupt, 240 

Directors,  54,  271-278 
Discharge    in    Bankruptcy,    239- 

243 

Dividends,     on     assignment     of 
debtor's  business,  214 

from  capital,  275,  276 

from  premiums,  132 
Dummy  Directors,  277 


Efficiency  Experts,  203 
Extension  of  Time  to  Debtors, 
208-211,  219,  220,  222 


False     Statements,     82-86,     119, 

122-124,  149,  241,  244 
Foreclosure,  law  of,  174 
Foreign  Creditors,  214 
Forms,    Bradstreet's   report,  93- 

95 

collection,  37,  39,  40,  42 

credit  information,  26,  35,  36 

financial  statements,  27-31,  66- 
72 

guaranty    of    payment    of    ac- 
count, 47,  48 

National    Credit   Men's   Asso- 
ciation statement,  68-72 

property  statements,  28-31,  68- 
72 

salesmen's  reports,  22,  23,  42 
Frauds,  12,  17,  126,  133-135,  I57» 
179-195,    200,    211,    216,    240, 

243  G 

Guaranty  of  Accounts,  44,  46 


INDEX 


H 

Homestead  Exemption,  168 

I 

Indebtedness,  limitation  of,  275 
Indorsement  of  Notes,  54 
Information,    Credit,    17,    22-39, 

64-101,  118-135 
through  mercantile  agency,  17, 

23,  73,  87-101,  118 
Insolvency,    196-245.      (See   also 

Debtors") 

Instalment  Collections,  in 
Insurance    in     Commercial    Af- 
fairs, 80,  246-264 
business,  248 
co-insurance,  255 
credit,  44,  261 
employers'  liability,  257 
fire,  80,  253-257 
industrial  accident,  258,  259 
life,  247-250 
marine,  250-253 

general  average,  251 
Lloyds,  253 

particular  average,  252 
personal  accident,  261 
public  liability,  260 
steam  boiler,  260 
Inventories,  81,  208 
Investigations,  credit,  20,  96,  103 
Investments,  192-194 
Involuntary     Bankruptcy,     215- 
217,  225 

Judgments,  166-169,  173 


Labor  Liens,  151,  238 
Lease,  fixture,  49 
Ledger  Accounts,  38,  43-45 
Liabilities,  56,  78,  127 

stockholders',  113,  242,  282-284 
Liens  on  Personal  Property,  136- 
158 

bankers',  153 

bottomry,  140 

labor,  151 

priority  of,  140 

vendor's,  151 
Liens  on  Real  Estate,  159-178 

attachments,   167,  168 

judgments  and,  166-169,  173 

license  tax  as,  161 


mechanics',  177,  178 

mortgage,  169,   170,  172-174 

tax,  160-166 

vendor's,  177 

Limitations,  Statute  of,  161 
Loans,  50-64 

on  collateral,  60-63 
Lloyds,  253 

M 

Mechanics'  Liens,  177,  178 
Mercantile       Agencies.         (See 

"Agencies") 

Misrepresentation,  149,  184-187 
Mortgages,  chattel,  142-147 
real  estate,  169,  170,  172-174 

N 

National   Association   of   Credit 
Men,  27,  67-73,  197,  229,  233 
financial  statements,  67-73 
National  Bankruptcy  Law,  228 
Notes,  50-64,  77,  in,  112,  172 


Officers,  powers  of,  273,  274 
Ownership  and  Possession,  142, 

154        P 

Partnership,  applying  for  credit, 

53 

property  statement,  68-70 
Personal  Property.     (See  "Prop- 
erty") 

Pledges,  141,  I47-I5I 
Preferred  Claims,  in  bankruptcy, 

235^239 
Professional   Men,  applying  for 

credit,  51 

Profit  and  Loss  Statements,  123 
Promoters,  278-280 
Property,  Personal,  78,  136-158 
Civil  Code  as  to,  137,  143 
common  law  as  to,  138 
conditional  sales,  115,  141,  154- 

157 

fraudulent  concealment  of,  241 
liens  on,  136-158 
mortgages  on,  142-147 
pledged,  147-151 
removal  of,  145,  146 
rights,  136 
sale  and  transfer  of,  136,  149- 

I5i 
warehouse  receipts,  153 


INDEX 


Property,  Real,  56,  78,  159-178 
attachments,  167,  168,  215 
deeds  in  escrow,  171 
fraudulent  sales  of,  180 
judgments,  166,  167,  169 
liens  on,  159-178 
mortgages    on,    169,    170,    172- 

174 

tax  sales,  163,  164 
Torrens   Land    Law   Registry 

System,  169 

trust  deeds,  170,  174-176 
Property  Statements,  28-31,  67- 

R 

Real    Estate.      (See    "Property, 

Real") 

Reclamation  Proceedings,  244 
Records,  credit,  34 

destruction    of,    by    bankrupt, 

240 

of  applicant  for  credit,  76,  121 
Referee  in  Bankruptcy,  234 
References,  bank,  30,  133 

outside,  25,  26 
Release,  of  debtors,  216 
Reports,  agency,   17,  23,  65,  73, 

91-101,  118 

board  of  trade,  34,  120 
collectors',  37,  38,  40-42 
salesmen's,  22,  42,  65 
Retail  Man,  applying  for  credit, 

58 
Rights  of  Possession,  155 


Sale,  bill  of,  49 

conditional,  115,  141,  154-157 
of  business  of  insolvent  debtor, 

205 

of  pledged  property,  149-151 
sheriff's,  167 
tax,  163,  164 
Sales  Credit  Limit,  81 
Sales    Department,    cooperation 
with   credit  department,   14, 
16,  21-24,  41,  42 
Salesmen's  Reports,  22,  42,  65 
Second  Mortgages,  173,  176 
Settlement    with    Debtors,    four 

types  of,  202 
Silence    Not    Misrepresentation, 

187 

Statements,  collection,  39-41 
corporation,  55-58 


false,  82-86,  119,  122,  124,  149, 

241,  244 
financial,  21,   25,  27-31,   64-86, 

190 

profit  and  loss,  123 
property,  28-31,  67-73 
written,  190,  191 
Stock,  Capital,  266-270,  279-282 
actual  value,  60-63,  282 
promotion,  279,  280 
watered,  280 
Stock  on  Hand,  76 
Stockholders,  113,  242,  267,  282- 

284 
Swindling  Schemes,  128-135,  149, 

157,  179-195 

System,  aid  to  efficiency,  9-19 
in  collection  department,  106 
Systems,    collection,   36-43,    104- 

117 
credit.     (See  "Credit") 


Tax,  city,  164 

franchise,  160 

inheritance,  165 

license,  161 

liens,  160-166 

poll,  162 

preferred  claim  in  bankruptcy, 
238 

sales,  private,  163,  164 

special,  164 

titles,  163,  164 

Time  Limit,  for  payment  of  ac- 
counts, 38 
Titles,  tax,  163,  164 
Torrens     Land     Law     Registry 

System,  169 

Transfers  of  Stock,  269 
Trust  Deeds,  170,  174-176 
Trustees  in  Bankruptcy,  229,  233, 

u 

Unearned  Increment,  130 


Vendor,  liens  of,  151,  177 

sales  by,  157 
Voluntary  Bankruptcy,  225 

W 

Written  Evidence,  189 
Written    Statements,    value    of, 
190,  191 


AUG    4 
.  Oil 


L  IS 


80m- 1,' 15 


UNIVERSITY  OF  CALIFORNIA  LIBRARY 





